LESS THAN a decade ago the return of high interest rates and bond yields seemed like a fantastical prospect, even to seasoned observers. “Like the pager, the Walkman and the Macarena, we’re unlikely to see such rates return,” said John Williams, then the head of the Federal Reserve Bank of San Francisco (and now of the New York Fed) in 2017. At the time yields on ten-year American Treasury bonds sat below 2.5%. During the covid-19 pandemic in 2020, they reached a nadir below 1%.
Stubborn inflation, corporate demand for capital and big public debts are squeezing holders of government bonds
Perhaps you should be practising your retro dance moves. On September 10th yields on the longest-dated American government bonds, maturing in 30 years, climbed to almost 5.4%, the highest level in nearly two decades. The ten-year Treasury yield briefly ticked up to 4.98%, almost matching a high-water mark from October 2023, when the Fed was raising interest rates in a tardy campaign to quash pandemic-era inflation. Around the world, bond yields are shooting up.
The pressure on bonds comes from a variety of sources. Most recently renewed fire between Iranian and American forces in the Gulf has driven oil prices sharply higher again. West Texas Intermediate, the American oil benchmark, has risen from less than $70 per barrel at the beginning of July to just over $100, dragging up inflation and creating a headache for central bankers. On September 11th the average price of a gallon (3.8 litres) of diesel in America surpassed $6 for the first time ever, to the exasperation of truckers and farmers, whose vehicles rely on the stuff. The same day the Bureau of Labour Statistics reported that “core” consumer prices, which excludes energy as well as food, rose faster in August than analysts had expected.
A more long-running concern is that many governments are unable to get their debts under control. America’s budget deficit is around 6% of GDP, even though the economy is strong. And on September 9th President Donald Trump pledged to pay American adults $5,000 each if the Republican Party maintains control of both houses of Congress at midterm elections in November, a splurge that would cost $1.2trn (3.5% of GDP). Though unlikely to be fulfilled, the promise shows how politics has become detached from macroeconomic reality. (Mr Trump also thinks the Fed should cut rates.)
A third factor that is probably pushing up bond yields is competition for capital from the private sector. The building of artificial-intelligence data centres is sucking up hundreds of billions of dollars, and contributing to an economic and financial boom that encourages investment and discourages saving. Whereas early in the boom the tech giants were financing much of this investment with their gargantuan cash piles, more recently they have issued debt in order to keep building. This year investment-grade borrowers are forecast to take out $1.9trn in debt, an increase of more than a third on 2025.
UBS, a bank, estimates that this rush of issuance by companies has raised ten- and 30-year Treasury yields by 0.2 percentage points. On September 1st Norway’s $2.3trn sovereign-wealth fund said it wants to slice sovereign debt from 70% to 50% of its bond holdings (if parliament approves). This would reduce its exposure to Treasuries by around $80bn, and increase that to the private sector.
The treasury secretary, Scott Bessent, a former hedge-fund manager, has set himself against the market. “I am the house now,” warned Mr Bessent in a speech in Texas on September 8th. “You can bet against me if you want.” He was referring to his intervention to prop up the Japanese yen, but sometimes gives the impression of harbouring a similar sentiment about Treasuries. The next day the Treasury Department announced that it would buy back up to $6bn-worth of long-dated government bonds in an effort to boost liquidity for the securities, tripling the size of its existing purchase programme. The hardman act did not work. Yields kept climbing.
The rise in yields is by no means uniquely American. Stubborn inflation, growing government debt and competition for capital are common problems. The yield is 5.3% on ten-year British gilts and 3.5% on German bunds, their highest levels since 2007 and 2011, respectively. Japan’s ten-year yields of 3% have not been this lofty in 30 years.
The knock-on effects of rising yields will be seen most immediately in other financial markets. They threaten the bull market in equities, especially the stocks of some richly valued tech firms. Higher yields raise borrowing costs for companies and make bonds more attractive to investors who might otherwise buy stocks. The housing market is also at risk. On September 10th rates on American 30-year mortgages rose to 7% for the first time in more than a year, according to one estimate.
Analysts fret over when, precisely, higher yields could make things break in the financial system. As the price of bonds falls (the inverse of rising yields), large holders face losses. In March 2023 the markets got a scare when Silicon Valley Bank, a tech-focused American lender, collapsed owing to a big hit to its Treasury holdings (plus weak risk management). At the end of June America’s banks were sitting on $327bn in unrealised losses, mostly in the form of bonds bought before the sharp rise in interest rates in 2022. Things are not as bad as that year, when they at one point recorded $688bn in losses. But if yields continue to climb, balance-sheets will come under further strain.
Central banks are reacting to the inflationary threat. On September 10th the European Central Bank raised its main interest rate from 2.25% to 2.5%. The Fed is expected to raise rates on September 16th, and the Bank of Japan on September 18th. Higher rates translate mechanically into higher bond yields.
It may be some time before governments themselves feel the full impact of higher yields. It takes a while for debts to mature. Only then do they need to be refinanced at the new, higher rates. But feel it they eventually will. The interest bill for America’s federal government ran to $931bn between October and July, already three times what it was in the same period in 2020. In many big economies government debts are far higher relative to GDP than they were 20 years ago, when bond yields were last around current levels. The combination of high debts and high interest rates will, if it persists, prove much more excruciating for finance ministers—and for taxpayers—than even listening to the Macarena.
