Sticky inflation, AI debt, and fiscal disorder create a triple threat: 30-year US Treasury yield hits highest level since 2007, triggering a "duration storm" in global bond markets

Zhitong Finance APP reports that long-duration bonds are becoming the focal point of investors’ concerns—a storm fueled by worries about the outlook for inflation and the debt burdened artificial intelligence (AI) boom, among other issues, and governments worldwide are paying the price.

Looking globally, sovereign borrowing rates have surged almost across the board. This week, the yield on the US 30-year Treasury reached its highest level since 2007, France’s borrowing costs hit post-2008 peaks, and yields on equivalent German bonds have returned to 2011 levels. UK long-term gilt yields are nearing 6%, while Japanese government bonds of similar maturities are also approaching historic highs.

Although each nation’s market is affected by local factors, the structural forces that are pushing yields higher are in fact common worldwide.

On one hand, there are market concerns that an increasingly divided global order will make national economies more susceptible to supply shocks, keeping inflationary pressures in place; on the other hand, bondholders worry that governments will struggle to control fiscal spending, thereby stimulating economies and forcing interest rates to remain high for longer. Meanwhile, changes in market structure and demographics are gradually weakening once-stable buy-side demand.

This amounts to a storm for finance ministers everywhere. Many countries are shifting their debt issuance focus to shorter-term instruments with lower yields. However, faced with a new reality where it’s no longer possible to lock in decades of financing at ultra-low rates, fiscal maneuverability ultimately becomes limited.

Chris Iggo, Chief Investment Officer at AXA IM Core under BNP Paribas Asset Management, noted: “It’s difficult to judge what level of yield would be sufficient to improve the total return outlook for long-dated fixed-income products. The only thing likely to change the game would be a sudden weakening of economic data or some external shock—the latter seems more probable.”

This year, the surge in energy prices triggered by tensions in the Middle East has battered the global bond market and fueled bets that the Federal Reserve and other central banks will further tighten monetary policy. However, the challenges facing fixed-income investors predated the outbreak of these tensions, and recent price action indicates that other factors are driving the upturn in long-term yields.

The yield on the US 30-year Treasury has climbed roughly 40 basis points since the end of June, reaching 5.32% on Tuesday, the highest since mid-2007. This is undoubtedly a tough issue for Trump and Treasury Secretary Besent, who face mid-term elections, as elevated government financing costs are feeding through to corporate loans and consumer credit.

Iggo of AXA noted: “The November elections could bring more policy risk and will certainly focus market attention on fiscal issues ahead of the usual budget season. Ideally, nobody wants to face rising mortgage rates during a critical election period—even if current rates are still below 2023 levels.”

The US Treasury market is only one piece of the bigger picture. Compiled data show that the average yield across investment-grade government bond benchmarks has soared to nearly 4.5%, the highest since records began in 2015.

Another source of pressure on long-term government bonds worldwide comes from competition with corporate borrowers. Bond issuance is proceeding at a record pace, injecting a substantial supply of duration into the US fixed-income market, spurred especially by technology firms seeking funding for AI investments, many of whom prefer longer-term financing.

These US companies are increasingly tapping international bond markets. For example, Alphabet Inc. (GOOGL.US) chose to make its debut in the Australian dollar bond market, issuing AUD 5 billion (about USD 3.6 billion).

As supply soars, the structure of buyers is also changing. Traditionally, many bond markets relied on demand for long-term assets by institutions like pension funds, matching their liabilities. Now, an increasing number of pension plans are exiting fixed-income portfolios, and regulatory policies are encouraging funds to allocate more toward equities.

More broadly, as governments ramp up bond issuance, they are relying more on private investors.

Minutes from the Federal Reserve’s June policy meeting indicated that officials noted the structure of Treasury holders was shifting from “official sector holders who are relatively insensitive to price, toward private investors who are more sensitive to price,” a transformation that could impact term premiums—the extra yield investors demand to hold long-term bonds.

Anshul Pradhan, Head of US Rates Strategy at Barclays, stated that “official demand is mainly driven by policy objectives,” whereas “private investors are more sensitive to returns.” He pointed out that this change in the buy-side structure over the past decade has contributed about 90 basis points to the term premium of US 30-year Treasuries.

In Japan, absolute yield levels are still below those of other major economies, but the recent upward trend remains relentless.

Japan’s relatively steep yield curve reflects speculation that the Bank of Japan’s pace of rate hikes to rein in inflation is too slow. Furthermore, the central bank’s decision to scale back bond purchases, along with market concerns over increased government spending and elevated energy costs, adds further pressure.

Prashant Newnaha, Senior Rates Strategist for Asia-Pacific at TD Securities, said: “The prospect of rising imported energy inflation and the growing tightening pressure on the BOJ provide almost no motivation for the market to buy JGBs. Japan was supposed to be the ballast for global interest rates, but with JGB yields climbing, the risk of a global duration repricing is rising.”

Although worries about price pressures have driven most of the current bond market selloff, in the majority of key markets, long-term breakeven inflation rates—that is, market expectations for future inflation—have remained relatively stable. In fact, what’s driving up borrowing costs is the so-called real yield—the extra return investors demand for holding bonds beyond inflation compensation.

Kelsey Berro, Portfolio Manager at J.P. Morgan Asset Management, believes this repricing process could present attractive entry points for new capital.

“We believe value is accumulating and our relative preference is for the long end, particularly in terms of real yield. We do indeed think that if risk assets experience more pronounced volatility, the correlation between different asset classes will ultimately support portfolios,” she said.