In late 2009, Greece came to market to sell some government bonds, and nobody showed up to buy them. Structural issues in the eurozone (namely a common currency, common central bank rates, and divergent fiscal regimes), which had been exacerbated by the global financial crisis and falling economic growth, all culminated in the European debt crisis, which lasted for years. For a while, investors did not have the confidence that they would get their money back from European government bonds.
More recently, in October 2022, the U.K. passed a budget that included too much spending and too many tax cuts, with the obvious implication of too much government borrowing ahead. Faith in the pound and gilts fell dramatically. 10-year gilts, which had already experienced rising yields from 2% to 3.25% over the previous month, jumped to over 4.5% in a matter of a few days. Inflation globally was running pretty hot, Awhich didn’t help.
The U.K. is not Greece. It enjoys its own currency, its own central bank, and is financially much larger and more developed. A number of levers were pulled, and things calmed down. But it did indicate that faith in government bonds is not 100%, even for large developed nations.
Last week, the U.S. 30-year Treasury yield broke through 5%. This level had been breached in 2023 (2nd grey box in the chart above), but that was when nominal GDP was expanding at a rather robust 6%+ pace. Or the previous move up in 30-year yields occurred in 2022 (1st grey box above), when inflation was around 8% and the economy was growing over 10%.
This recent move up in long yields is not driven by spiking inflation or an economy heating up. It appears to be driven by risk: risk that the U.S. government may run into financial trouble, making a 30-year hold seem a bit too long, or requiring a bit of extra yield to take the risk.
Concern over the budget making its way through the houses, combined with perhaps a bit less enthusiastic international buyers following the tariff policy flip-floppery, are adding to the “narrative.” Some articles pointed to a drop in the bid-to-cover ratio for an auction of 20-year Treasuries. Really? The 20-year is an odd bond, and it dropped from 2.63x subscribed to 2.46x.
But these rising long yields are not just an American story. The long-dated bonds for many nations have been rising of late, including Canada, the U.K. and Japan. Japan, once the land of no yield, is now getting some yield. Is this evidence that debt sustainability has become an issue around the world due to high deficits and high debt levels? Not so fast.
As we discussed last summer, the composition of bond buyers has changed over the past decade or so. In the 2010s, the majority of bond buyers were what we would call “yield insensitive” or inelastic. In the U.S., the Fed was implementing quantitative easing, buying bonds and never caring what the yield was. Foreign banks saddled with US dollars from net exports to the U.S. had to convert or park them in Treasuries. Domestic banks with too much capital, given so much money in the system and not enough loan demand, would park money in Treasuries to improve capital ratios. These were inelastic bond buyers; they just don’t care if it yields 1% or 5%.
However, over the past few years, the above cohort has shrunk in size. Limited growth in global trade has led to less buying by foreign banks, plus a bit of reluctance to hold as many bank reserves in Treasuries is evident. The Fed is no longer a big bond buyer. Domestic banks are not that active as net buyers either. Filling the void has been accomplished mainly by households and money market funds, both driven by a typical investor. Investors, like you and me, are yield elastic.
With yield-elastic buyers in the driver’s seat, this should help keep yields more rangebound and higher than they were in the 2010s, which were dominated by inelastic yield buyers. If yields fall, fewer buyers should limit how low yields move. And if yields rise, more buyers may be enticed to do some buying.
Overall, this should keep yields more rangebound. And this recent move up in yields has enticed more buying. For more timely reading, the chart below shows the net assets in the five biggest U.S. bond ETFs. You may notice the increase over the past few weeks (slope of aqua line) as yields moved higher, and now yields are starting to cool a bit.
In the short term, we are not discounting the impact on bond yields should inflation or economic growth change direction, which would certainly impact yields. We are also aware that the U.S. has enjoyed lower issuance levels over the past few months, thanks to tax receipts, with issuance (a.k.a. supply) increasing in the coming months or if the market goes risk-off for any other reason. However, the impact of any changes in these dynamics on yields will be somewhat muted given the elasticity of yield demand by investors.
Longer term, there is a debt sustainability risk, but this is likely a muted risk today. A high debt-to-GDP ratio does not beget a crisis. More important is the yield environment relative to economic growth. If yields remain higher than growth for an extended period, there is greater risk of a crisis. Today, U.S. nominal GDP is growing at 5-6%, still decently higher than overall yields.
Final Thoughts
We are not saying bond yields can’t move up from here, but if they do, more buyers will likely show up. This should limit how high yields can climb in the near term and keep them somewhat rangebound. We do believe the pace of U.S. deficits is high given the low unemployment and economic growth. But we’re not convinced this will lead to runaway yields anytime soon. And should the economy start to cool, we believe yields will likely come down.
— Craig Basinger is the Chief Market Strategist at Purpose Investments
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Sources: Charts are sourced to Bloomberg L. P.
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