In 1993, James Carville, a senior adviser to US President Bill Clinton, made an unusual wish. If he were reincarnated, he said, he would rather return as the bond market than as a pope or president. The reason was simple: the bond market could intimidate almost anyone, especially politicians who built their reputations on ambitious spending programmes and mounting debt.
Now that often-overlooked market is demonstrating precisely that power again.
Across major economies, the cost of borrowing for 30 years has risen to levels not seen since the global financial crisis of 2007. In the United States, the yield on 30-year government bonds recently reached 5.34 per cent, its highest level since the financial crisis. Germany’s 30-year Bund yields climbed to 3.78 per cent, while France reached 4.9 per cent — just below the five per cent threshold and above levels seen during the euro crisis from 2010 onwards and during France’s government crisis of several years ago.
“The rise in yields is shaking investor confidence,” says Jochen Stanzl, market strategist at Consorsbank. Stephan Kemper, a market strategist at BNP Paribas, puts the message more bluntly: the bond market is sending unmistakable signals that ever-higher government debt is no longer popular with investors.
The numbers help explain why.
In the United States, the Congressional Budget Office recently increased its forecast for government debt by another $200 billion, while the country’s debt exceeded $40 trillion for the first time on Tuesday. Germany faces increased borrowing needs because of billions in spending on defence and infrastructure. France, meanwhile, had to raise almost 20 per cent more money during the first five months of this year than during the same period a year earlier to service its debt. The chief auditor of France’s Court of Auditors has warned that, in the worst case, the country could “suffocate” under the burden of interest payments.
Yet investors are not currently expecting an immediate sovereign-debt crisis across the industrialised economies. Instead, the bond market is already pricing in the risks created by higher government spending.
One concern is energy. Higher energy prices resulting from the Iran war could force governments to spend more to shield companies and households from an energy shock, potentially through measures such as fuel discounts or tax reductions.
Commodity prices create a double problem. Brent crude has risen above $90 a barrel, while Europe’s benchmark gas price is higher than it was at the beginning of the Iran war. If another wave of inflation spreads to goods and services, bond investors fear that the real value of the relatively modest interest payments offered by many bonds could decline. Selling becomes more attractive.
What makes the current turmoil particularly striking is that even apparently reassuring economic data have failed to calm the market. US inflation figures recently came in lower than expected. At the CME futures exchange, investors had only days earlier assigned a 60 per cent probability to the US Federal Reserve raising interest rates in September because of inflationary pressure. That probability has now fallen to around 30 per cent.
Under normal circumstances, lower expectations for interest-rate increases could be expected to push bond yields down. Instead, yields are rising.
Understanding why requires following the complicated mechanics of the bond market.
When investors sell government bonds, they generally do so at lower prices. Investors who buy those bonds at the reduced prices can earn higher returns if they hold them until maturity. Governments seeking to borrow new money then have to pay interest rates based on the prevailing market yield. In effect, borrowing becomes more expensive for the state.
The mechanism resembles a domino effect. A fall in bond prices pushes yields higher; higher yields increase the cost of new government borrowing; and higher borrowing costs can place further pressure on public finances.
For much of the 2010s, this confrontation between governments and major investors seemed almost forgotten. Central banks kept policy rates close to zero, making borrowing cheap. But the pandemic and Russia’s war against Ukraine sent energy prices sharply higher, followed by increases in interest rates. The balance of power began to change.
The bond vigilantes began to return.
The term was coined in the 1980s by Ed Yardeni, formerly chief strategist at Deutsche Bank. His idea was that investors would demand higher yields when politicians embarked on spending binges or fuelled inflation through excessive government expenditure. At some point, governments might simply become unable to afford the higher interest costs and would be forced to change course.
Britain provided a recent example in 2023, when Prime Minister Liz Truss pursued tax cuts that investors considered inadequately calculated. The confrontation between the government and financial markets ended with her resignation.
The US Treasury is now attempting to calm the market in another way. US Treasury Secretary Scott Bessent announced that the government intended to double its bond buybacks. The measure is designed not only as a signal of confidence but also to improve the tradability of certain long-dated US government bonds.
Older bonds can trade less frequently than newly issued securities, meaning relatively small orders can sometimes cause disproportionately large market movements. Following Bessent’s announcement on Wednesday afternoon German time, yields on 30-year government bonds fell by more than 0.1 percentage point — an unusually large movement in the bond market.
But the deeper problem is not simply government debt. It is the changing balance between supply and demand for capital.
“Here, a battle for capital and liquidity is raging,” says Thomas Altmann of asset manager QC Partners.
Governments are not the only borrowers. Companies also raise money through the bond market, traditionally including banks and industrial firms. The artificial-intelligence boom is now changing the picture. Amazon, Alphabet, Meta and Oracle alone borrowed almost $200 billion through the bond market during the first half of the year. Forecasts suggest that they could raise more than $400 billion there next year.
Technology companies, which previously tended to turn to bond markets only in exceptional circumstances, have therefore become some of their largest participants.
At the same time, an important source of demand has weakened. For years, central banks around the world were major buyers of government bonds, helping suppress yields. Since abandoning their zero-interest-rate policies, however, many central banks have been retreating from the bond market.
More borrowers want money. One major class of buyer is buying less.
France offers a revealing example. When the government auctions new bonds to authorised major banks, central-bank data show that speculative hedge funds are increasingly among those expressing interest. In Japan, the central bank is also withdrawing from the bond market while other investors remain cautious. Relatively small orders can therefore trigger disproportionately large market reactions, prompting calls for the Bank of Japan to resume larger purchases.
The consequences are not confined to governments and institutional investors.
Households can feel the effects indirectly through borrowing costs. Mortgage rates, for example, are influenced by government-bond yields. When yields rise, new property loans generally become more expensive. So far, according to the comparison portal Interhyp, the recent rise in capital-market yields has not yet translated into higher financing conditions in Germany.
Equity investors, however, have already felt the shock. The more attractive bond yields become, the more institutional investors may consider moving money away from shares. Technology stocks are particularly vulnerable because many of their expected profits lie far in the future. Investors therefore compare the potential future returns from high-growth companies with what they can earn from relatively secure government bonds.
As government yields rise, the valuation of distant future earnings becomes less attractive. The effect has been especially pronounced among technology and artificial-intelligence companies, whose shares have driven much of the global market advance in recent years. An index of the 30 most important US semiconductor stocks fell by more than five per cent on Tuesday.
Even bond investors are not automatically protected.
An investor who buys an individual government bond now and holds it until maturity can benefit from the higher yield. But millions of private investors do not hold individual bonds. They own bond ETFs, which track indices containing large baskets of securities.
That creates a complication. Older bonds already held inside an ETF lose value when market yields rise. Newly added bonds offer higher yields, but the existing securities still weigh on the fund’s value. As Stefanie Kühn, a fee-based financial adviser from Westerstede near Oldenburg, explains, even an apparently safe bond ETF can therefore decline in value for periods of time.
As a rule of thumb, a one-percentage-point rise in overall market interest rates can cause many government-bond ETFs to fall by roughly seven per cent. German ten-year government-bond yields have already risen by around 0.4 percentage point since the beginning of the year.
The measure known as modified duration can provide investors with a more precise indication of how sensitive an ETF is to changes in interest rates.
Carville’s old description of the bond market as powerful enough to frighten politicians is therefore proving relevant once again. But there is another possibility that may matter just as much for investors.
Government bonds have traditionally served as a refuge when stock markets become turbulent, often rising when shares fall. The recent bond-market upheaval raises a more uncomfortable question: if the artificial-intelligence boom were to collapse, would investors still be able to rely on bonds to provide the same protection?
After the events of recent days, that once-familiar assumption looks considerably less certain.
