Bond sell-off deepens as fears grow over inflation, oil prices

SINGAPORE – Global bonds sold off sharply on Sept 2, extending a rout that is raising borrowing costs to multi-decade highs as the Middle East conflict pushes up energy prices, playing into investor fears about inflation and ballooning government debt.

Sovereign yields are a reference point for asset prices across global financial markets, and the higher price of money means higher mortgage rates for consumers and tougher choices for government spending as funding costs ratchet up.

The yield on 10-year US Treasury notes, which sets the tone for borrowing costs across the world economy, hit a three-year high. It is nearing the 5 per cent level that could unsettle already jittery stock markets.

Japan’s 10-year yield was perched above 3 per cent, a 30-year high.

German 10-year Bund yields were stuck at their highest since 2011, and Britain’s equivalent was at its highest since 2008.

Australia’s 10-year government bond yields rose to 5.198 per cent, their highest level in more than 15 years.

A confluence of factors was at play, said State Street’s head of macro strategy, Michael Metcalfe, with rising energy prices causing traders to bet on rate hikes, pushing up short-dated yields.

“The narrative is also getting wrapped up with longer-term concerns about the fiscal path. In France and the UK, we are going to get news on budgets soon. So, there are not many positives out there,” Metcalfe said.

A spree of bond sales from big tech companies aggressively raising money to fund the AI boom has added pressure on the sovereign bond market.

Naka Matsuzawa, chief macro strategist at Nomura Securities in Tokyo, said hyperscalers’ willingness to pay reasonably high rates was pulling up yields across the board, with the focus now on whether growth can rise along with them.

“The (AI-driven) productivity leap needs to translate into higher wages,” he said.

Bond vigilantes assemble?

Global bond routs have become increasingly common in the past few months as the energy shock due to the Middle East war rattles investor nerves over rising debt loads across major economies and inflation risks.

Governments are borrowing heavily after a jump in spending during the Covid-19 pandemic and the Ukraine war energy crisis. They also face ageing populations, rising welfare bills, and higher defence investment needs.

Britain’s new government, led by Prime Minister Andy Burnham, will present a budget in October, while France is gearing up for further battles over its next budget.

And in Japan, the bond yield surge has put the spotlight on Japanese Prime Minister Sanae Takaichi and her aggressive investment plans.

“Rising JGB yields,” said Fred Neumann, chief Asia economist at HSBC, “not only reflect investor concerns over Japan’s fiscal outlook, with ambitious spending plans signalled for the coming years, but also global pressure on long-term funding costs.”

“Japan and the UK look closest to the front line because rising yields are colliding with fiscal pressures and changing monetary regimes, while France also remains vulnerable given its debt trajectory,” said Charu Chanana, chief investment strategist at Saxo.

These pressures have raised the spectre of “bond vigilantes”, a reference to global debt investors who seek to impose fiscal discipline on governments that they perceive to be profligate by demanding higher compensation for holding their bonds.

“The fear is that the bond vigilantes are on the loose,” said Ed Yardeni, president of Yardeni Research, “and driving yields higher in protest over large government deficits, mounting government debt and rapidly rising government interest costs.

“We share the bond vigilantes’ concerns, but we aren’t convinced bond yields are, or will soon be, prohibitively high,” said Yardeni, who coined the term Bond Vigilantes in the 1980s.

“If it (the US 10-year yield) hits 5 per cent, we expect strong demand for the bond, including from Treasury Secretary Scott Bessent. He’ll issue more Treasury bills to buy back bonds if necessary to avert a selling panic,” Yardeni said.

The US Treasury stepped into markets in August to cap a rise in long-end bond yields, although the impact of the move was short-lived, with the yield on 30-year Treasuries back near its highest in 19 years.

Nick Ferres, chief investment officer of Vantage Point Asset Management in Singapore, said rates have reached a level where they will start to pressure public and private sector debt service, with higher yields also weighing on valuations, particularly in long-duration growth sectors.

“If the policy answer becomes some form of financial repression (like yield curve control or quantitative easing), that would likely be incredibly bullish for gold,” Ferres said.

Fiscal focus

Rising energy costs continue to dog economies, fuelling traders’ rate-hike bets.

Brent crude oil hit a one-month high on Sept 2 after the US and Iran traded strikes, while European natural gas prices are at their highest since early 2023.

Federal Reserve chairman Kevin Warsh triggered a sharp rise in bets on a September rate hike with a hawkish speech last week in which he acknowledged there had not been enough progress on inflation.

The rate-sensitive two-year US Treasury yield, which typically moves in step with interest rate expectations for the Fed, rose to 4.41 per cent, its highest level since January 2025.

Traders have priced in a rate hike in Europe next week and about a 68 per cent chance of a US rate hike the week after that. REUTERS