By Amanda Cooper, Karen Brettell, Laura Matthews and Gertrude Chavez-Dreyfuss
LONDON/NEW YORK, May 15 (Reuters) – Bond markets are bracing for interest-rate pain in a way they have not in decades, as investors assess the economic costs of the war with Iran and how the global economy will bear those burdens.
Benchmark 10-year U.S. Treasury yields hit their highest in around a year on Friday, two days after the government sold 30-year bonds at the highest yield since 2007, as traders anticipated the Federal Reserve would be forced to hike rates to rein in inflationary pressures stemming from energy shocks.
Rising Treasury yields have a broad impact on other assets around the globe.
“With sticky inflation, higher rates are going to be here for longer,” said Seth Hickle, portfolio manager at Mindset Wealth Management in Indianapolis, who said this would have ripple effects on home buying, corporate lending and purchasing power. Benchmark Treasury yields are the government security most influential to mortgage rates.
Investors said the broad selloff reflected a week of high inflation readings and the realization that the war in Iran was likely to continue to stoke higher energy prices, following a meeting between the U.S. and China that yielded no significant news on the Middle East situation. Brent crude rose 4% to exceed $109 a barrel.
Higher benchmark yields could also present headwinds for U.S. stock prices, as companies and consumers will face higher borrowing costs. This can also weigh on economic growth and corporate profits, while possibly making bond returns more competitive with stocks. Major global stock indexes were down between 1% and 2%, a day after the S&P 500 and Nasdaq hit new highs.
Friday’s market swings also reflected a sense among many investors that trading in U.S. stocks had grown disconnected from global economic fundamentals, due to excitement driven by the surging corporate profits tied to artificial intelligence investments.
U.S. indexes have surged back to record highs in the month-and-a-half since the markets’ Iran war scare bottomed out at the end of March, a surge that raised eyebrows because it seemed at odds with sharply higher energy prices and related disruptions.
“There’s a realization that the market had gotten way ahead of itself,” said Kenny Polcari, chief market strategist at Slatestone Wealth Management in Jupiter, Florida. “It wasn’t paying enough attention to what the bond market and economic data is telling it. It was caught up in this momentum AI trade.”
Next week, the bond market faces another test with a 20-year U.S. Treasury auction scheduled. That follows a run of soft auctions this week which underscored strain in the market.
Some pointed to the inflation-adjusted, real yield as leading Friday’s move. U.S. 10-year real yields, or those on Treasury Inflation-Protected Securities, hit 2.083%, the highest since March 27.
That reinforces the view that the Fed can afford to stay on hold for longer, a backdrop that risks extending the bond selloff. Interest rate futures prices on Friday reflected a growing conviction that the Fed will raise interest rates late this year or in early 2027.
“When I see the real yield rising, it’s telling me that this is not an economy where the Fed is about to cut rates,” said Padhraic Garvey, head of global rates and debt strategy at ING in New York.
BOND YIELDS RISING EVERYWHERE
Though the bond rout was sweeping the globe, many of the drivers were at least partly local in nature. UK gilt yields surged again, hitting their highest in decades, as pressure mounts on Prime Minister Keir Starmer to resign over his Labour Party’s hefty losses in local elections, and as challengers emerge.
Yields across the euro zone jumped, while Japanese bond yields hit record highs following a red-hot wholesale inflation reading this week that investors believe is likely to lead to rate increases from the Bank of Japan.
Italian 10-year bonds were among the worst performers, with yields up 11 basis points to around 3.89%, bringing the rise for the week to 16 bps, while benchmark German Bund yields rose almost 7 bps to around 3.12%, up 11 bps this week.
The selling pointed to an inflation-driven change in market sentiment, with increasing scrutiny of government spending and related issues.
“The political turmoil in the UK has pushed gilt yields higher and called into question fiscal sustainability there. You have a tendency to say there’s a problem in the UK, who could be next,” said Eric Winograd, chief U.S. economist at AllianceBernstein. “Japan could be next, the U.S. could be next.
As we roll into the midterms it’s entirely possible we get new fiscal policy but we haven’t seen anything here that would drive this.”
ARE THE VIGILANTES ON THE PROWL?
When global bond markets get rattled, talk often turns to the “bond vigilantes,” the fixed-income investors who decades ago were said to have forced governments to cut spending by demanding higher yields. While the turmoil in U.K. and Japanese markets shows signs that these dynamics could re-emerge, investors said this week that the acute issue is how high energy prices and rising inflation readings will play out at central banks.
“Global yields have probably come to the point where they are high enough to hurt sentiment,” DBS senior rates strategist Eugene Leow said.
(Additional reporting by Rae Wee in Singapore, Twesha Dikshit in Bengaluru, Sinead Carew and Caroline Valetkevitch in New York and Matt Tracy in Washington; Editing by Alex Richardson, Colin Barr, Megan Davies, Daniel Wallis, Rod Nickel and David Gregorio)
