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Federal Reserve Board Chairman Kevin Warsh speaks during a news conference in Washington, on Sept. 16. If central banks maintain their hawkish stance, the bond sell-off could continue and expose deeper fiscal vulnerabilities across the developed world, David MacNicol writes.Mark Schiefelbein/The Associated Press
David MacNicol is president and portfolio manager at MacNicol & Associates Asset Management.
The recent synchronized rise in global yields is not simply a U.S. fiscal or monetary story.
Investors are reassessing global debt levels, persistent inflation and a changing world order marked by geopolitical conflicts and trade disputes. These concerns have increased bond market volatility and have begun affecting many balanced-oriented portfolios.
As yields and bond prices move in inverse directions, sharp increases in yields have produced losses for many fixed-income investors, and that will likely continue.
Long-duration government yields have jumped to multidecade highs globally, especially across the developed world, with the U.S. 10-year treasury yield moving above 5.6 per cent, Japan’s 10-year yield near 3 per cent, and the British 30-year yield above 6 per cent. Global long-term yields are signalling something beyond the typical response to central bank interest-rate increases: a lack of confidence from investors in the fiscal and monetary situation around the world.
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Central banks now face a difficult task – balancing fragile economic growth with elevated inflation. They are expected to be overly hawkish during this cycle after getting it wrong during the last inflationary cycle, post-pandemic.
These central banks do not want to be wrong twice and will be fighting more than inflation; they will be fighting the recent memory of having misread the situation and investor confidence. However, keeping rates high for too long could produce severe economic damage. If central banks maintain their hawkish stance, the bond sell-off could continue and expose deeper fiscal vulnerabilities across the developed world.
Governments are feeling the effect and consequences of higher yields. The U.S. Treasury recently tripled its bond buyback program from US$2-billion to US$6-billion. The Treasury claimed its decision was aimed at increasing liquidity in the Treasury market. However, many investors are questioning the timing of the decision and have concluded the program is intended to minimize the increase in interest rates.
The Treasury has also received political backlash for intervening in bond markets just a few weeks before U.S. midterm elections, as higher borrowing costs and affordability remain key issues for voters. Higher yields don’t only affect consumers, but they also affect governments that are servicing massive deficits.
As we have seen, this move by the Treasury has not decreased interest rates; it has increased long-term rates and led to many investors questioning the independence of the Treasury and its motives. Treasury Secretary Scott Bessent has faced criticism, including from his former mentor Stanley Druckenmiller, over his handling of this situation. Druckenmiller, who famously shorted the British pound and “broke the Bank of England” in the 1990s, warned in an opinion piece last month that governments who defend prices against fundamentals always lose, and the variable is how much they spend before conceding.
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Meanwhile, the U.S. Federal Reserve’s interest-rate policy has had rippling effects across global markets through currency movements, capital flows and imported inflation. Higher U.S. interest rates attract capital, support the U.S. dollar and place pressure on other currencies.
Central banks worldwide are feeling these pressures and are attempting to protect domestic currency purchasing power, while avoiding further economic pressure from higher interest rates. Japan’s move away from ultra-low interest rates and consistent inflation worries in Europe could intensify global volatility in bond markets and could lead to further weakness.
For investors and consumers, higher benchmark rates mean higher borrowing costs and lower bond prices. Many balanced portfolios that rely on fixed income to cushion equity drawdowns have instead seen both asset classes fall, a repeat of 2022. The recent rise of yields has pushed bond prices down, affected investor sentiment and triggered credit-fund outflows.
Higher yields are not fundamentally negative: they can improve income for investors and normalize bond market pricing after years of near-zero yields. The danger today is not simply the level of yields, but the volatility and speed of bond-price adjustments, which are being intensified by fiscal vulnerabilities that adversely affect consumers, investors and governments.
Ultimately, global bond-market performance may not be entirely determined by monetary policy, and will likely be ascertained by investor sentiment toward inflation cyclicality and their belief in policy-makers’ control over it. Fiscal policy is expected be a driver of bond-market performance, as investors want governments to show their actions are sustainable and not volatile.
Global bond markets may remain unusually volatile as numerous parties navigate an uncertain economic environment.