Global bond yields have risen for six months. Why matters more than by how much. A changed cyclical picture, with inflation firmer and growth better than expected, points to one conclusion. Doubts over government finances would point to another, and to a riskier world. The evidence favours the first: expectations have shifted from modest rate cuts to modest rises, yield curves have flattened rather than steepened, and no country has had a ‘Liz Truss’ moment.
A cyclical move, not a fiscal one
The maturity that moves tells you which forces are at work. At shorter maturities central bank policy dominates, itself a response to growth and inflation. Beyond ten years, fiscal credibility, the behaviour of pension funds and insurers, and quantitative tightening matter more. Diagnosis begins with the shape of the curve, not the level of any one yield.
Since the repricing of 2022, the US ten-year yield has traded between roughly 3.5% and 5%. At 4.9% it sits close to the top of that range, but this is not unknown territory. Shorter maturities are mid-range, whilst yields beyond 20 years have broken above their post-2022 range. Outside the US, yields have drifted up since 2022, spreads against Treasuries have narrowed, and UK yields have moved above their US equivalents.
The past six months have a clear signature. The rise has been global, similar in scale across countries and, in every major market except Japan, larger at the short end. Yield curves have flattened. In January markets expected small cuts in the US and Europe. Higher inflation, driven largely though not solely by energy prices following conflict in the Middle East, together with firmer growth, has replaced that with a consensus for modest increases.
Real rates, profits and AI borrowing
Splitting nominal yields into real rates and inflation expectations sharpens the point. All of the rise in US ten-year yields since the spring has come through higher real rates. Long-term inflation expectations have held steady for years, across a wide range of conditions.
Two candidates explain higher real rates. The first is the exceptional increase in corporate profits: if companies can borrow profitably at higher rates, governments will pay more too. The second is the surge in external financing by US technology firms to fund AI capital expenditure, with heavier issuance lifting yields for all borrowers. Aggregate corporate borrowing has risen by much less, and the issuance looks like a feature of the next year or two rather than a sustained increase in supply.
Why fiscal fears are not the main driver
Concerns over fiscal sustainability bite hardest at long maturities and steepen yield curves. Curves have flattened. Fiscal pressures also arrive on national timetables, set by elections and domestic policy, so they correlate across countries largely by chance. The synchronised move since February points to a common cyclical factor, and no major fiscal news has emerged to warrant it.
Two US policy developments have drawn attention. The removal of Federal Reserve forward guidance under Chairman Warsh has reduced clarity over policy, and some commentators attribute 0.1% to 0.25% of the rise in yields to it. That looks high: the change came as the case for higher rates was building. The Treasury’s buybacks of 20 and 30 year bonds have had limited market impact, though the incoherence of depressing long yields as the Fed moved the other way has shown up in a weaker dollar.
None of this makes fiscal risk irrelevant. Higher yields mean higher debt service costs and, although these accrue slowly, the arithmetic is unforgiving and narrows the choices on tax and spending.
The UK: inflation, not unique fragility
The UK is the obvious test case, with the highest long-term yields in the developed world and press coverage attributing them to government borrowing. The numbers do not support that reading. UK debt relative to GDP is lower than in the US and Japan, whilst the budget deficit is half that of the US. Higher ten-year yields instead reflect higher short-term rates, required because UK inflation is more deeply ingrained. The gap between ten and 20 year yields, around 0.5% and a better proxy for fiscal risk, is not discernibly above the developed market average.
The wider backdrop
The global economy shows evidence of a mild cyclical upswing, helped by the AI capital spending cycle. The renewed energy shock will reduce output in some regions, with Europe and Asia more exposed than the US, but activity has proved less sensitive to the oil price than feared. Risks are asymmetric rather than acute, and the probability of a global recession this year remains low.
Rising yields depress bond prices today and raise prospective returns tomorrow. This year the two have roughly offset: returns on the Bloomberg corporate 1 to 10 year index have been modestly positive, trailing cash slightly.
Saranac positioning
Three themes run through our fixed income portfolios. First, as for the past decade, we own no bonds with maturities beyond ten years, a stance that has contributed materially to returns. A one point rise in rates would cost a 20 year gilt investor over 10% of capital, against less than 4% for a five year gilt, where coupon income would recover a one-off move inside a year. Second, we avoid government bonds where immediate fiscal risk is high and rising, France ahead of next year’s elections among them. Third, we are not cutting duration at shorter maturities: higher starting yields improve prospective returns and reduce sensitivity to any further rise. US inflation-linked Treasuries now offer a real return of 2.5% over ten years, unavailable for almost 20 years.
The wider allocation follows the same logic. Equity valuations remain somewhat elevated and credit spreads have little room to tighten, whilst fixed income yields look increasingly attractive against the earnings yield on equities. A more diversified allocation has merits. Our portfolios are not positioned aggressively for the worst outcomes, and tactical tilts remain moderate.
Read the September Outlook here.
This commentary is intended for information purposes only. It does not constitute a personal recommendation, financial promotion, or regulated advice. Past performance is not a guide to future returns. All views are those of Saranac Partners and are subject to change.
