The world’s largest sovereign bond markets are heading toward one of their weakest months in years as rising energy costs fuel inflation concerns and artificial intelligence-driven growth expectations push investors to prepare for an environment of higher interest rates for longer.
Two-year U.S. Treasury yields have surged nearly 60 basis points in September, putting them on track for their biggest monthly increase since early 2023.
Short-term borrowing costs in France, Germany, the United Kingdom and Australia are also set for their largest monthly increases since March, when the Iran war triggered a new energy shock. Japanese government bond yields remain near multi-decade highs.
“There is a realisation that the whole energy story and inflation story will not go away in the very short term,” said Kenneth Broux, Societe Generale’s head of corporate research for foreign exchange and rates. “Bond markets are adjusting to that.”
Investors Adjust to a Higher Rate Environment
For some investors, rising yields have made government bonds more attractive again. However, others remain cautious about longer-term bonds due to concerns over elevated government debt levels.
October will bring additional market tests, including the latest U.S. employment and inflation data, French budget discussions, a new U.K. budget and potentially more bond issuance from technology companies funding artificial intelligence investments.
Higher Interest Rates Could Persist
Sovereign bond markets play an important role because they influence borrowing costs for businesses and consumers, including mortgage rates. Rapid increases in borrowing costs can create risks for financial markets and economic growth.
Unlike 2022, when bond returns suffered their worst performance on record, investors are concerned not only about the speed of the current move but also the elevated level of global interest rates.
Recent data showed that rates on the most popular U.S. home loans have climbed to their highest level in more than two years.
Ten-year U.S. Treasury yields, which recently moved above 5% for the first time since 2007, are on track for their largest monthly increase since 2022, rising around 50 basis points.
The ICE BofA MOVE Index, which measures bond market volatility, has increased nearly 30% in September, marking its largest monthly rise since March.
Despite the volatility, some investors see opportunities. Florian Ielpo, head of macro and multi-asset portfolio management at Lombard Odier Investment Managers, said he has become more positive toward government bonds due to higher yields.
He expects government borrowing costs to remain elevated as markets compete with major technology companies issuing bonds to finance artificial intelligence investments.
According to LSEG data, bond issuance from large technology companies has more than doubled this year, surpassing $200 billion.
Fiscal Concerns Add Pressure in Europe
European bond markets are also facing pressure from government budget uncertainty, particularly in France and the United Kingdom.
Political tensions in France have contributed to significant bond market moves. The country’s 10-year bond yield has increased more than 50 basis points this month, its largest monthly increase since 2022, widening the gap with German government bonds to its highest level since 2012.
“Now you have additional idiosyncratic risks in France’s case. People are asking where the budget is, whether there will be a budget, and what happens next,” said Andrzej Szczepaniak, senior European economist at Nomura.
U.S. Policy Uncertainty Remains a Concern
In the United States, investors are focused on the outlook for monetary policy following the Federal Reserve’s September rate increase and actions by the Treasury aimed at managing borrowing costs.
While the rate increase strengthened the Fed’s position in fighting inflation, uncertainty remains around future policy decisions.
“Policy uncertainty is coming at us from two places, the Fed and the Treasury, and I am deeply uncomfortable about the U.S. policy mix,” said Arun Sai, senior multi-asset strategist at Pictet Asset Management.
