"The bond market storm" triggers global panic, but the pain may just be beginning
JPMorgan Chase pointed out that factors such as de-globalization, an aging population, and increased spending on climate change will drive the 10-year Treasury yield to remain above 4.5% in the long term. Peters from PGIM Fixed Income stated that if the 10-year yield rises above 5% in this environment, he "wouldn't be completely shocked at all."
As we enter 2025, the "debt market storm" sweeping across is ringing alarm bells for global investors.
U.S. Treasury yields have surged, with the 10-year Treasury yield rising over 100 basis points in just four months, now approaching the psychological threshold of 5%. This is a rare scenario since the 2008 global financial crisis.
The rapid changes in the U.S. Treasury market have quickly impacted global markets, with bond yields in major economies like the UK and Japan also climbing. Gregory Peters, Co-Chief Investment Officer of PGIM Fixed Income, pointed out that the current market conditions resemble a "tantrum-style" sell-off on a global scale.
The economic policies implemented by Trump upon his return to the White House have further increased borrowing demand. His growth-prioritized policy direction, including tax cuts and deregulation, has raised market concerns about the risks associated with soaring government debt.
JPMorgan Chase noted that factors such as de-globalization, an aging population, and increased climate change spending will drive the 10-year Treasury yield to remain above 4.5% in the long term. Peters from PGIM Fixed Income stated that if the 10-year yield rises above 5% in this environment, he "wouldn't be completely shocked."
Initial Signs of a Global Debt Market Storm
Over the past decade, low interest rates and loose monetary policies have accustomed the global economy to cheap capital. Now, this change in environment is significantly increasing financing costs for businesses and households.
The U.S. 30-year fixed mortgage rate has risen back to around 7%, and the high borrowing costs are beginning to dampen stock market investors' optimism while putting pressure on corporate credit quality.
Historically, high 10-year Treasury yields have often been a precursor to market and economic crises, such as during the 2008 financial crisis and the bursting of the internet bubble. While some debt holders have temporarily avoided the impact due to locking in lower rates, if the current trend of high yields continues, potential risks will gradually accumulate.
Even more concerning is the continuously widening U.S. fiscal deficit. According to projections from the Congressional Budget Office, the budget deficit as a percentage of GDP in 2025 could exceed 6%. Trump's economic plan, which includes extending the tax reform policies from 2017, is expected to add $7.75 trillion in debt over the next decade.
Although the Federal Reserve has begun cutting interest rates since September 2024, the resilience of the U.S. economy and the stubbornness of inflation have made the room for rate cuts more limited. According to the latest data, December's non-farm payrolls showed a strong rebound, and the inflation indicator favored by the Federal Reserve rose 2.4% year-on-year, although lower than the pandemic peak of 7.2%, it remains above the 2% target. Several Wall Street banks, including Bank of America and Deutsche Bank, have lowered their expectations for interest rate cuts in 2025.
Kathy Jones, Chief Fixed Income Strategist at Charles Schwab & Co Inc., stated in an interview with Bloomberg on Friday:
"The Federal Reserve doesn't have much room to talk about interest rate cuts in the short term."
In addition, the market shows signs of weakening demand for long-term bonds. Bloomberg data shows that since the Federal Reserve began cutting interest rates, the U.S. Treasury Index has risen by 1.5%, while the S&P 500 Index has increased by 3.8%. The broader global bond market has cumulatively fallen by 24% since the end of 2020.
Deteriorating Fiscal Conditions Raise Concerns of "Bond Vigilantes"
In addition to monetary policy, fiscal policy has become an important factor affecting the bond market. Policies such as tax cuts and increased infrastructure spending by the Trump administration may further widen the fiscal deficit, raising investor concerns about the sustainability of U.S. debt, and "bond market vigilantes" have once again become a focal point of discussion. Albert Edwards, a global strategist at Société Générale, stated:
"As politicians clearly have no interest in fiscal tightening, the bond vigilantes are slowly awakening. The notion that the U.S. government can borrow in extreme circumstances because the dollar is the world's reserve currency will certainly not hold forever."
The economic policies implemented by Trump upon his return to the White House further increased borrowing demand. His growth-prioritized policy direction, including tax cuts and deregulation, has raised market concerns about the risks associated with soaring government debt. The responsible federal budget committee estimates that Trump's economic plan (including the continuation of the 2017 tax cuts) will result in a debt level that is $7.75 trillion higher than currently projected for fiscal year 203.
Bloomberg predicts that by 2034, the U.S. debt-to-GDP ratio will reach 132%. Many market observers believe this is an unsustainable level.
Is 4.5% Just the Beginning? Analysts: A High-Interest Rate Era May Fully Begin
Internationally, countries such as the UK, France, and Brazil are also under market pressure due to budget issues. Last week, the yield on 30-year UK government bonds soared to its highest level since 1998, as the market expressed dissatisfaction with the fiscal plans of the newly elected Labour government.
Peters from PGIM Fixed Income stated that if the 10-year yield rises above 5% in this environment, he "wouldn't be completely shocked at all." JPMorgan pointed out that factors such as de-globalization, an aging population, and increased spending on climate change will drive the 10-year Treasury yield to remain above 4.5% in the long term. Bank of America believes that the bond market has entered its third "great bear market" in 240 years.
Moreover, investors' required risk premium for long-term bonds is also rising. Models from the New York Fed show that the term premium for 10-year Treasuries has reached its highest level in over a decade. Zachary Griffiths, head of U.S. investment-grade and macro strategy at CreditSights, stated that this indicates growing market concerns about the U.S. fiscal outlook:
"The steepening of the curve also aligns more with the historical relationship between massive deficits and rising deficits."
Nevertheless, some viewpoints suggest that high yields will ultimately have a suppressive effect on the economy, prompting the Federal Reserve to re-accelerate easing measures. Some investors still expect that adjustments in risk assets will lead to a rebound in the bond market Jim Bianco, the founder of Bianco Research, pointed out that a yield level of 5% is not necessarily a bad thing, but rather a normal state before the financial crisis.
In any case, the wave of adjustments in the global bond market has profoundly changed the investment environment. For investors and policymakers, adapting to the new normal may be the only option at present