Not only the Federal Reserve, but also the central banks of the United Kingdom and the United States are losing control over interest rates.

The imminent issue in the bond market is that while central banks around the world are reducing their bond purchases, bond issuance is on the rise, leading to overseas central banks losing control over interest rates.

According to media reports on Tuesday, in order to attract market buyers, G7 countries need to offer higher yields. The premium on bond maturities in countries like the UK and the US has rebounded to levels seen before the 2008 financial crisis, indicating that the actual "control" over interest rates is shifting from central banks to the market.

A clear example is that, according to Morgan Stanley, without the intervention of the Federal Reserve, US bonds have automatically "raised interest rates three times". Last week, Powell's speech seemed to acknowledge this point. During the Q&A session at the New York Economic Club, he said that if the decline in long-term US bonds leads to a sustained tightening of financial conditions, it would indeed reduce the Fed's perceived need for rate hikes.

Since the financial crisis, central banks around the world have implemented quantitative easing policies and significantly increased bond purchases to support the economy and the market. As a result, the private sector only needs to absorb a small amount of sovereign debt issued.

Even during the most severe period of the pandemic, when public sector deficits soared and quantitative easing policies were intensified, it severely distorted major government bond markets. The Bank of Japan owns more than 50% of Japanese government bonds, while the German bond market has only about 20%-40% of bonds available for private investors.

Due to the ability of private investors to arbitrage between G7 bond markets, these distortions have lowered global yields. In fact, the presence of a large number of price-insensitive buyers (central banks) has reduced the uncertainty of future yield levels.

The so-called "term premium" (the additional return that investors bear for interest rate risk over a longer period of time) has collapsed globally, and this distortion has also affected market pricing and the ability to indicate neutral interest rates, i.e., the interest rate level at which monetary policy can keep the economy in balance.

However, the situation has now reversed. Central banks are exiting the bond-buying stage, and the private sector has to absorb a large amount of sovereign debt.

Specifically, in terms of bond supply, governments around the world are issuing a large amount of bonds due to massive deficits. On the demand side, as major central banks have entered a phase of quantitative tightening, either actively selling government securities or no longer reinvesting in maturing bonds, the main buyers now are the price-sensitive private sector.

Currently, bond supply affects overall yield levels through the "term premium". Since private sector investors have many other options for bond investments, yields must rise to be more attractive.

For example, in a recent 30-year US bond auction, primary dealers (large banks and top securities firms) purchased 18% of the total amount, compared to an average of only 11% in the past two years. This weak demand signal has led to an increase in US bond yields. When all G7 governments issue a large amount of bonds at the same time, in order to attract them, bonds from countries with the same default risk need to offer higher yields. This is an important reason for the recent rebound in term premiums. Expectations of a large supply of bonds in the future also have a similar impact on term premiums. In 2022, US government bonds experienced the largest decline since 1871. Due to this situation and expectations of a large issuance of bonds in the future, investors will be cautious about holding an excessive amount of government bonds.

Due to the increase in expected issuance, the uncertainty about future yield levels has led to higher term premiums today. In some countries, such as the UK and the US, term premiums have reached levels seen before the 2008 financial crisis. However, considering the large issuance, quantitative tightening, and investors' cautious attitude towards future yield levels, term premiums could easily rise further from their current levels.