Global Bond Market Turmoil

As we enter the new year, the global bond market has been on a turbulent roller coaster rideThis year has seen a significant spike in U.STreasury yields, commonly regarded as the "anchor of global asset pricing." Within just four months, the yield on the benchmark 10-year U.STreasury bond skyrocketed by over 100 basis points, nearing the psychological threshold of 5%. The last brief breach of this landmark level took place in 2023. Moreover, the yield on the 30-year Treasury bond has also reached 5%, prompting many financial experts on Wall Street to consider this yield rate the new norm.

Taking a closer look at the landscape of international bond markets, yields in the United Kingdom, Japan, Germany, and other countries have followed suit and surged recentlyFor instance, on January 8, the yield on Britain's 10-year bond climbed to 4.82%, marking the highest level since 2008. Just a day later, Japan's 10-year bond yield increased by one basis point to 1.185%, the highest since May 2011. This trend continued on January 10, as yields from various European countries saw significant rises: France’s bond yield went up by 3.6 basis points to 3.425%, Germany's by 3 basis points to settle at 3.00%, while Italy and Spain recorded increases of 6.1 and 3.6 basis points, respectively.

Investor sentiment toward the global bond market has now taken a more cautious turn as yields continue to climbAccording to JP Morgan, several factors including de-globalization, an aging population, and increased spending due to climate change are saying that the 10-year Treasury yield could remain elevated at 4.5% or above for the long termPeters from PGIM Fixed Income added that if the 10-year yield were to surpass 5% in this environment, it would come as no surprise to him.

Amid these developments, the prospect of an interest rate cut by the U.SFederal Reserve appears to have diminished significantly

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Bloomberg noted that even as the Fed joins other major central banks in cutting rates, U.S. yields are still on the uptrend—a shocking dissonance that is almost unprecedented in historyThe Fed, set to begin its rate cut cycle in September 2024, faces challenges in maneuvering due to the resilience of the U.S. economy and persistent inflation, limiting the room for further cuts.

A report released by the U.SBureau of Labor Statistics on January 10 reveals that non-farm payroll employment increased by 256,000 in December, far exceeding the expected forecast of 160,000. The unemployment rate dipped to 4.1%, with average hourly earnings growing by 0.3% since November of the previous yearFollowing this robust employment data, major Wall Street firms have revised their forecasts concerning further rate cuts by the FedFor instance, Goldman Sachs now predicts only two rate cuts this year, against previous expectations of three, tentatively scheduling reductions in June and December.

Bank of America, which initially anticipated two 25-basis-point rate cuts this year, has now shifted to the outlook that there may not be any cuts, potentially even signaling a rate hikeMeanwhile, Barclays has adjusted its expectations to predict a 25-basis-point cut in June 2025, having earlier indicated two rate cuts in March and June this yearMarket sentiment reflects a consensus shift, with the CME Group's "FedWatch" tool suggesting the probability of only one cut this year is now above 60%.

Regarding the fiscal landscape, beyond monetary policy, fiscal policy has become a significant driver shaping the bond marketPresident-elect Biden's administration is expected to implement tax cuts and bolster infrastructure spending, thereby potentially inflating the federal deficit and raising investor concerns about the sustainability of U.S. debtAccording to the Congressional Budget Office, Biden's economic plan could lead to an increase of $7.75 trillion in debt levels above current projections for the fiscal year 2023.

Bloomberg forecasts that by 2034, the debt-to-GDP ratio in the U.S. could reach as high as 132%, a level many market analysts deem unsustainable

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Consequently, investment giant PIMCO disclosed that it has grown more conservative regarding long-term U.STreasury investments, now favoring short- to medium-term bonds over long-term ones.

Yao Ting Zhao, a strategist for Invesco in the Asia-Pacific region (excluding Japan), shared insights indicating that Biden's proposed tax cuts, while likely to stimulate economic growth, would exacerbate the already critical fiscal position of the U.S. treasury and drive inflation higherAdditionally, tariffs could further sustain elevated levels of inflationThe issue of high government debt and fiscal challenge is not unique to the U.S.; many prominent economies, including South Korea, France, Germany, and the U.K., face similarly pressing budgetary dilemmas.

Currently, the yield on the U.K.’s 30-year bonds is at its highest level since 1998, a reflection of increasing market unease regarding long-term fiscal riskAnalysts point out that Britain’s net public sector borrowing is nearing 100% of GDP, placing substantial constraints on government fiscal policyThe Labour government has promised to boost economic growth over the next five years while gradually reducing the debt-to-GDP ratio; however, the rising bond yields present a significant challenge for these goals.

Michiel Tukker, a senior euro rates strategist at ING, asserts that rising government bond yields could trigger a self-reinforcing feedback loop through increased borrowing costs in budget drafting, further worsening the U.K.'s debt sustainability.

Investors are also increasingly alert to the potential danger of simultaneous declines in both stocks and bondsHistorically, surges in 10-year Treasury bond yields have signaled tumultuous shifts in markets, such as the financial crisis of 2008 and the burst of the internet bubble a decade earlierAlthough the ultra-low rates in recent years have allowed some borrowers to secure favorable terms, somewhat cushioning them against the impact of the latest yield increases, there remains the risk of accumulated pressure if these trends persist.

At present, the yield on the S&P 500 is approximately 1 percentage point lower than that of the 10-year Treasury bond—an occurrence not seen since 2002. Morgan Stanley observes that if Treasury yields escalate further, the stock market could face more substantial declines

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