Global bond tantrum is a wrenching and worrisome start to 2025

New York – For those unsettled by the relentless rise in government bond yields in the US and across much of the world lately, the message from markets is getting clearer by the day: Get used to it.

The world’s biggest bond market and global bellwether is leading a reset higher in borrowing costs, with the prospect of a prolonged period of elevated rates carrying consequences for economies and assets everywhere. 

Just days into 2025, yields on US government debt are surging as the risks to supposedly super-safe assets mount.

The economy continues to power ahead – Jan 10’s blowout employment report provided the latest evidence – while the Federal Reserve is rethinking the timing of further interest rate cuts, and Donald Trump is returning to the White House with policies prioritising growth over debt and price fears as borrowing has soared.  

The rate on 10-year notes alone has soared more than a percentage point in four months and now is within sight of the 5 per cent barrier last breached briefly in 2023 and otherwise not seen since before the global financial crisis nearly two decades ago. 

Longer-dated US bonds have already touched that milestone, with 5 per cent seen by many on Wall Street as the new normal for the price of money. Similar spikes are playing out internationally, with investors increasingly wary of debt from Britain to Japan.

“There is a tantrum-esque type of environment here and it is global,” said Mr Gregory Peters, who helps oversee about US$800 billion (S$1.1 trillion) as co-chief investment officer at PGIM Fixed Income. 

For some, the shift upwards in yields is part of a natural realignment after years of a near-zero rate environment following the emergency measures taken after the 2008 financial crisis and then the Covid-19 pandemic. But others see new and worrisome dynamics that present major challenges.

Given its role as a benchmark for rates and signal of investment sentiment, the tensions in the US$28 trillion US bond market threaten to impose costs elsewhere.

Households and businesses will find it more expensive to borrow, with US mortgage rates already back at around 7 per cent, while otherwise upbeat stock investors are beginning to fret higher yields could be a poison pill for their bull market.

Corporate credit quality, which has remained generally strong amid the benevolent economic backdrop, also risks deterioration in a higher-for-longer-rates environment.

Historians point out that rising 10-year note yields have foreshadowed market and economic spasms, such as the global financial crisis as well as the previous decade’s bursting of the dot.com bubble. 

And while the ultra-low rates of recent years allowed some borrowers to lock in favourable terms that have helped shield them from the latest yield surge, pressure points may build if the trend persists.

US yields are rising even after the Fed joined other major central banks in embarking on a course of rate cuts – a jarring disconnect that has few precedents in recent history. 

That easing of US monetary policy, which started in September 2024, was expected to continue in lockstep with a slowing economy and inflation, setting up bonds to rally. 

Instead, the economy has stayed solid, as seen by December’s jump in jobs growth, and the resilience has sown doubts over just how far and how fast inflation can slow.

The Fed’s favoured inflation gauge rose 2.4 per cent in the year through November 2024, way below its pandemic-era peak of 7.2 per cent but still stubbornly above the 2 per cent comfort level of central bankers. 

Jan 15 sees the release of December 2024’s US consumer price index, which is predicted to show underlying inflation cooling only slightly.

Consumers remain on guard: The latest sentiment reading from the University of Michigan revealed inflation expectations for the next five to 10 years at the highest since 2008.

Several Fed policymakers recently signalled they support keeping rates on hold for an extended period.

In markets, swaps reflect a similar viewpoint, with the next quarter-point cut not fully priced in until the second half of 2025.

A number of Wall Street banks on Jan 10 trimmed their forecasts for 2025 cuts in the wake of strong jobs data. Bank of America and Deutsche Bank do not see the Fed easing at all in 2025.

The continued pricing out of Fed rate cuts in 2025 only compounds the poor performance of US government bonds compared with riskier assets such as stocks. 

The Bloomberg Treasury index has started the year in the red and is down 4.7 per cent since just before the Fed’s first cut in September, compared with a 3.8 per cent gain for the S&P 500 and a gain of 1.5 per cent for an index of Treasury bills.

Beyond the US, a global index of government bonds has lost 7 per cent since shortly before the Fed cut in September, extending the decline since the end of 2020 to 24 per cent.

The recalibration in rate expectations also helps explain why, according to Deutsche Bank, 10-year Treasuries are suffering their second-worst performance during 14 Fed easing cycles since 1966.

Enter the bond vigilantes?

Monetary policy is only part of the picture, though. As US debt and deficits pile up, investors are becoming increasingly fixated on fiscal and budgetary decisions and what they may mean for markets and the Fed, especially ahead of January’s return of Trump and a Republican-run Congress.

Tellingly, the term “bond vigilantes” – a decades-old moniker for investors who seek to exert power over government budget policies by selling their bonds or threatening to do so – is cropping up again in commentary and conversations on Wall Street.

The fiscal footprint is already huge. The non-partisan Congressional Budget Office estimated in 2024 that the budget shortfall is on track to exceed 6 per cent of gross domestic product in 2025, a notable gap at a time of solid growth and low unemployment.

Now Trump’s preference for tariffs, tax cuts and deregulation sets the stage for even bigger deficits, as well as the potential for accelerating inflation. 

As politicians “apparently have zero appetite for fiscal tightening, the bond vigilantes are slowly waking”, said Mr Albert Edwards, global strategist at Societe Generale.

“The argument that the US government can borrow in extremis because the dollar is the world’s reserve currency surely won’t hold good forever,” he said. BLOOMBERG