Tiny changes often are nothing more than that: small, meaningless shifts. I tell myself that whenever I gain a couple of pounds. Who cares? It doesn’t matter, unless it turns out to be a trend — and my pants no longer fit.
Bond yields are a little like that. Small increases don’t really matter. But when they continue, and when those yields cross certain thresholds, those increases can matter a great deal.
Bond yields and prices move in opposite directions. Falling prices and ascending yields over the last couple of weeks have broken through important psychological levels, including at least one that was last breached in 2007, just before the great financial crisis.
Climbing yields mean higher costs for mortgages and loans, adding expenses for ordinary people and business executives alike and, ultimately, slowing the economy. Whether the bond market right now is signaling serious trouble ahead or simply offering investors some enticing deals can’t really be known. But, suddenly, it’s worth paying close attention to those tiny changes in numbers.
Consider that on May 13, at the government’s auction of brand-new 30-year Treasuries, buyers demanded an interest rate of 5.046 percent — and that a yield above 5 percent hadn’t been required to sell those bonds since 2007. On the open market, 30-year Treasury bonds were trading with yields just below 5.2 percent on Wednesday.
Recall that 2007 marked the start of an enormous recession, deep unemployment and a tremendous downturn in the stock market. Yields fell sharply as the economy shriveled and demand for goods and services shrank. The Federal Reserve cut short-term interest rates to near zero, and the bond market dropped longer-term rates, too.
Those were terrible days. That kind of calamity hasn’t happened this year, and it may not occur at all. But the shift in bond yields is arresting, and it would be foolish to ignore it. It may well signify intensifying concern in the bond market about inflation — set off in part by the spike in oil prices due to the war in Iran and the extra costs stemming from President Trump’s tariffs.
The stock and bond markets have been diverging, as I’ve pointed out in previous columns. Swept up in enthusiasm for artificial intelligence, equity markets have been shrugging off the war, tariffs and other real-world problems far more easily than the bond market. But at some point, if bond yields rise sharply and rapidly enough, stock investors will have a hard time maintaining their optimism, which is based primarily on the potential for profits from A.I. Rising bond yields could eventually slow economic growth so much that there could be a global recession.
On the other hand, if the war in the Middle East ends soon and oil prices drop, reducing the threat of runaway inflation, bond yields could decline — producing profits for bond traders. And long-term investors who lock in today’s rates could benefit for years from a richer income stream.
Does it make sense to be relaxed about higher yields or to worry about them? Alas, like the prudent response to putting on a few extra pounds, the answer is undoubtedly a little of both: There’s no need to panic, but it’s not wise to be complacent, either.
The Global Bond Market
Rising bond yields aren’t just a U.S. phenomenon. Interest rates have been climbing around the world.
Each country has its own idiosyncratic problems. In Britain, for example, yields on long-term bonds, or gilts, have been trading close to their highest levels in 30 years, partly for political reasons. There have been perceptions of instability in the Labour Party government led by Prime Minister Keir Starmer since it endured big losses in local elections this month.
Even so, traders in the global bond market have generally been bidding down bond prices — and raising yields — often in response to a worldwide threat of higher inflation posed by the war in Iran. The war has frozen the decision-making of many central banks, which control the shortest-term interest rates.
What has happened is that the effective closing of the Strait of Hormuz, through which much of the world’s energy supplies and fertilizer move, has already led to higher prices for oil, natural gas and gasoline at the pump, and to rising costs for businesses, farmers and consumers in the United States and much of the world.
Whether this is a temporary problem will depend on the conduct of the war and its aftermath: how quickly the strait reopens, how safe it becomes and how much damage has been done to energy infrastructure in the Persian Gulf region.
But with a higher rate of inflation, investors naturally expect to receive higher rates of interest for their money. Bond yields, which are set by traders, have been rising, and shorter-term rates controlled by central banks have largely held steady — with expectations in financial markets that the central banks will have to raise rates, too, if inflation gets out of control.
Europe and Japan both face the risk of stagflation — slowing growth along with rising inflation. In Germany, the yield on 30-year bunds, or government bonds, has drifted around 3.7 percent this week, the highest level since 2011, according to FactSet, while the German government projects economic growth of just 0.5 percent in the year ahead. In Japan, bond yields reached their highest levels since 1998, while economic growth is expected to “decelerate” below 1 percent, according to the Bank of Japan.
The U.S. Case
There are few signs of an economic slowdown in the United States, which is a net energy exporter, and where a combination of gigantic expenditures on A.I. infrastructure and a yawning fiscal deficit is stimulating growth. But inflation is already worrisome.
Futures markets in the United States now expect the Fed to keep rates steady — or perhaps raise them — despite Mr. Trump’s stated preference for lower rates. The incoming Fed chair, Kevin M. Warsh, has also indicated his support for lower rates, at least in the past.
Aside from the inflation surge, there are other reasons for elevated Treasury yields. For one thing, after years of rising national debt, government shutdowns and bond downgrades, U.S. Treasuries are no longer the highest-rated sovereign bonds in the world. Yet the supply of Treasuries offered by the government keeps growing as the United States piles on debt. This has happened under several presidential administrations but has accelerated under Mr. Trump.
As a result of these factors, the “convenience yield” for holding Treasuries — or the benefit, in comparison with holding other sovereign bonds — has declined, according to research by scholars including Wenxin Du, a Harvard finance professor. This factor alone has probably increased the yield of many Treasuries by as much as a quarter of a percentage point, compared with sovereign debt of other advanced countries.
Aswath Damodaran, an influential New York University finance professor, has recommended that for some purposes, financial analysts should subtract a quarter of a percentage point from Treasury yields to account for the premium that investors demand for holding them.
Then there are contingent, short-term actors. While the bond market is typically less volatile than the stock market, bond traders must assess whether the momentum of big moves in bond prices and yields is too powerful to fight. Even if bonds are fairly valued now, it’s possible that yields will keep rising simply because they have been heading upward. Such thinking propels markets for a while, until prices (and yields) look so out of whack that a correction occurs.
Up, Down or Sideways?
For long-term investors — not traders — current bond yields may already be reasonably priced, as long as the intention is to hold on to them for an extended period. High-quality bonds are useful in diversifying investment portfolios during market downturns and recessions — though inflationary environments are not usually good for bonds.
In 2022, when inflation at one point exceeded 9 percent, bonds lost value rapidly. But people who stuck with their bonds until maturity avoided taking actual losses. Similarly, investment-grade bond funds declined sharply in value in 2022 but have largely recovered, despite a setback again this year, as interest rates have risen.
Now that yields and prices have begun moving sharply, I’ve been paying close attention to the bond market. In comparison with stocks, bonds have been providing a sober view of the world.
If the war in the Gulf ends soon and the rate of inflation declines, bonds will probably benefit. In fact, yields and prices may already be bargains.
But that is still a big question. Soaring inflation would hurt the bond market. It’s where bonds will be heading, rather than where they are right now, that we need to worry about.
