Long-term bond yields signal a more uncertain and costly outlook

Long-term bond yields, particularly in the US, have drawn much attention in recent weeks. The yield on the US 10-year Treasury bond, a widely used proxy for the global risk-free rate, has risen to around 4.8% while the yield on the 30-year Treasury has climbed to 5.25%. Neither yield has been this elevated since 2007.

Several factors are at play in the US Treasuries market, by far the largest in the global economy:

• US gross Federal government debt hit a record high of US$40 trillion in mid-August, increasing by US$1 trillion in less than five months. The Congressional Budget Office sees US debt rising from 101% of GDP in 2026 to 120% of GDP in 2036, indicating that debt issuance is likely to remain high at a time when growth in foreign holdings has slowed.
• While longer-term inflation expectations have remained anchored in the US, inflation has persisted above target in recent years. The Middle East conflict has flared up again, sparking a resurgence in fuel prices. This has contributed to expectations that policy rates may remain higher for longer.
• The Federal Reserve has de-emphasised the need to provide guidance on future policy decisions lest it influence markets. Instead, it has expressed a preference to be guided by unfiltered market signals, including the prices and trading volumes of Treasury securities. Meanwhile, the US Treasury is intervening in the long-term bond market not just to support market liquidity but also to ease pressure on long-term yields. Investor concerns about fiscal and monetary policy potentially being at odds could be placing upward pressure on term premia.
• Finally, artificial intelligence investment is now competing for longer-term capital. Hyperscalers are increasingly issuing long-dated debt to fund AI infrastructure expansion.

Long-term yields have risen across the G7, not just in the US. In Japan, the 10-year bond yield breached 3.0% for the first time since September 1996, while the yield on the 30-year government bond touched 4.18% at the start of the month. Persistent cost-push inflation, a weak yen, expectations of higher policy rates, elevated sovereign debt, and record-high budget requests have all contributed to higher yields in Japan.

Dynamics in the US and Japan have contributed to a broader rise in bond yields across advanced economies. The United Kingdom, Germany, France, Italy, and Canada have witnessed a bond sell-off sending yields markedly higher (see chart 1). The common thread across these economies is elevated debt and rising deficits driven by factors such as increased defence spending and the sizeable capital required for the clean-energy buildout. Exposure to geopolitical volatility, including the conflict in the Middle East and the war between Ukraine and Russia, has also played an important role.

In Australia, the 10-year bond yield recently rose above 5.2%, reaching a 15-year domestic high and ranking among the highest 10-year yields in major advanced economies. Australia’s federal government gross debt recently exceeded $1 trillion, having risen from $56 billion around the time of the Global Financial Crisis in 2008. Persistent domestic inflationary pressures and higher global energy prices have also contributed to the upward pressure on yields.

Why do long-term bond yields matter?

Given the elevated level of sovereign debt across developed economies, a relatively small movement in long-term yields can push debt servicing costs up sharply. Higher debt could place further upward pressure on long-term yields and, in an adverse scenario, create a self-reinforcing deterioration in fiscal sustainability.

Higher long-term bond yields could also constrain fiscal policy support in the event of an economic downturn. Many developed economies were already facing elevated public debt and persistent fiscal deficits prior to the COVID-19 pandemic. Since then, those fiscal pressures have increased significantly.

Corporate borrowing is also likely to come under pressure as higher sovereign yields push up corporate interest rates. This could weigh on investment decisions while also increasing the financial risks associated with large-scale investment in AI and energy infrastructure.

Finally, higher long-term rates could weigh on consumer spending by raising mortgage and other borrowing costs. More importantly, central banks may need to tighten monetary policy if higher inflation expectations become a stronger feature of the rise in long-term yields.

With so many factors at play in several economies across an interconnected global financial system, it is hard to parse the contribution of each factor to higher long-term bond yields. It is equally challenging to accurately gauge where the risks lie. The message from bond markets is not that a fiscal crisis is imminent, but that capital is no longer cheap. Governments should not assume that investors will continue to finance rising debt obligations without demanding a higher return.