By Chris Iggo, Chair of the Investment Institute and CIO for AXA IM Core, BNP Paribas Asset Management
A 6% yield on 30-year US Treasury bonds has not been seen since the end of the last century. Some bond bears think we might see that yield again soon.
A key difference between now and then is that today there is a lot more government debt. Consequently, higher yields threaten a potential bond crisis for governments. That, in turn, might impact on credit and equity markets. Investors need to be more vigilant than ever.
- Key macro themes – Threats to economic resilience remain
- Key market themes – Potential for volatility to increase post-summer
Bond panic
The bond panic is not likely to turn into bond euphoria. Potential bond rally triggers include weaker economic data, more dovish central banks, or an equity market correction – one which is significant enough to negatively affect the economic outlook. But right now, none of these are present.
Instead, government debt concerns have risen to near-hysterical levels. It is clear why. Debt is a liability for governments, and it is rising. There was a lot of noise around the US Federal debt level exceeding $40 trillion recently.
The bigger the liability gets, relative to income (GDP), then the odds are that there will be higher borrowing costs and potential refinancing difficulties. Such outcomes have negative financial, political, and social implications.
Current concerns about the rise in US government long-term bond yields have pushed the US government into increasing its buy-back operation of long-term Treasury bonds. There has even been talk of using the Treasury’s General Account to fund these buybacks.
Floating unconventional policy ideas is not good for market sentiment. It makes investors question what the motivation is. Given the US is just over two months away from its midterm elections, some may conclude the key motivation is political.
I mentioned recently that rising mortgage rates are not an ideal backdrop for the incumbent government. US 30-year average mortgage rates hit 6.8% recently. There is a hint of panic in the air.
Roughly 22% of outstanding US Treasuries are trading with a market yield above 5%. Those bonds, collectively, were issued with an aggregate average coupon of 3.25%. As a thought exercise, if all the bonds currently yielding more than 5% were to be refinanced today, that would increase the US Treasury’s interest bill by over $4 billion.
Negative trend
Of course, there are complex reasons why long-term yields have been rising. One is the ever-present concern about increasing government budget deficits across the developed world.
The ongoing situation in the Middle East could push inflation higher again, leading to central banks having to tighten monetary policy. There is also an element of normalisation: bond yields were generally higher before the global financial crisis, when they reflected greater levels of nominal GDP growth (largely because inflation tended to be higher).
There has also been an increase in capital demand. This year is on track to be a record year for corporate bond issuance, driven by technology companies raising funds to finance the artificial intelligence infrastructure build.
Net equity issuance should also be positive – again technology companies are at the forefront of this but the recently announced planned IPO by fashion company Shein in Hong Kong ($1.8 billion according to Bloomberg) suggests the demand for capital goes beyond the AI race. Investors are being asked to commit a lot of money.
Increased demand for capital should raise the price of that capital (yields). It certainly seems to have – 30-year government bond yields are up anywhere between 25 basis points in Germany, to 70bps in Japan.
Assets as well
The focus on bonds as a liability is the core of the credit market, and investors need to consider the macroeconomic and credit risks before investing. However, bonds are an asset as well, and an important one for financial institutions and households.
One borrowers’ debt security is another investors’ financial asset. The interest paid by the borrower on the debt represents investment income to the lender.
I will repeat that long-term bonds have not been a great asset in recent years, with bond prices collapsing during the interest rate reset and remaining sensitive to inflation, interest rates, and fiscal developments.
Rising yields based on increased borrowing are ‘dilutive’ – the borrower must pay back more creditors and new borrowing is priced at the higher yield, which means diminished prices for bonds that were issued at lower yields.
With an income focus, bonds are attractive
But looking through the ‘bonds as an asset’ prism, yields are more attractive. Market commentary suggests a 5% yield on 10-year US Treasuries (4.7% currently) would trigger a buying spree. Existing yields in the UK and eurozone are well above current inflation rates and the 10-to-15-year sector looks particularly interesting given the shape of yield curves.
Note that bonds’ income streams are a valuable component of any portfolio. Fixed income strategies that have limited interest rate risk (short duration) and reasonable credit spreads are amongst the most attractive.
Investing in a US five-year corporate bond with a 5.25% coupon today should potentially generate a compound total return of 29% over the maturity of the bond, with the principal repaid as well.
High yield markets offer even greater return potential, albeit with more risk to capital because of the potential for borrowers defaulting (which has been low in recent years).
But long-end volatility might remain, and spread
Income is one thing, but volatility can impact the mark-to-market valuation of a bond portfolio significantly. The US is where risk is most evident, given the uncertainty over the Federal Reserve’s policy direction under new Chair Kevin Warsh, and the fiscal outlook.
Most corporate borrowing is taking place in the US. And keep in mind that US market yields are, to a significant extent, dependent on the willingness of the rest of the world to buy the dollar and US financial assets.
There is no compelling evidence that this is changing, but the more fractious international political environment could impact on flows eventually.
The upside for US yields may be greater than elsewhere as America needs to keep on attracting the most capital. Elsewhere, there are attractive yields in European government and credit markets with less fundamental risk.
In the UK, the gilt market has been volatile and there are concerns about inflation and government borrowing. A significant gilt rally, and therefore lower yields across the sterling market, is unlikely to occur until the next budget – the first under new Prime Minister Andy Burnham – is delivered.
Seatbelts on
The September-to-October period has been one of the more volatile parts of the year historically. The US midterm elections will be a key market focus, as will be the Middle East and energy market developments. If the bond vigilantes get upset, the risk is this will start to push credit spreads wider and impact equity market valuations.
Markets might be due a correction. The sense of us being in a Goldilocks economy is a fragile one. Higher inflation and interest rates are risks. Less optimism about AI is another. The geopolitical backdrop is tense. Bonds might lead the way – they are doing so already. But bonds may also signal the next buying opportunity. A 6% US 30-year yield has not been seen since before the millennium, and one today would make bonds extremely cheap relative to equities.
Performance data/data sources: LSEG Workspace DataStream, ICE Data Services, Bloomberg, BNP Paribas AM, as of 26 August 2026, unless otherwise stated). Past performance should not be seen as a guide to future returns.
