Expectations for interest rate hikes are rising, with the average yield on global government bonds approaching 4%, reaching a new high since 2007.

The rise in interest rate expectations, combined with high inflation and fiscal financing demands, has driven global bond yields to continue to rise, putting pressure on Asian markets and significantly increasing bond market volatility.

Written by: Li Jia, Wall Street Journal

The global bond market is facing a new wave of selling pressure, with inflation retreating less than expected and high fiscal financing needs prompting a reassessment of interest rate paths, as expectations for "higher rates lasting longer" continue to intensify.

On Thursday, September 24, Bloomberg reported that the Bloomberg Global Aggregate Bond Index yield rose by 8 basis points to 3.99% on Wednesday, just a step away from the 4% mark, reaching a level rarely seen since 2007, with the largest single-day increase since May. Meanwhile, the yield on U.S. five-year Treasury bonds broke through 5% for the first time since 2007. The swap market has now priced in three expected rate hikes of 25 basis points each over the next year, with expectations for a fourth hike also intensifying.

The impact of the bond market sell-off is also spreading to other assets and the real economy. The financing costs for governments, businesses, and households are under upward pressure, and higher risk-free yields will also raise the discount rate for risk assets like stocks, suppressing their valuations. At the same time, bond market volatility has significantly increased, with the ICE Bank of America MOVE Index rising to its highest level since March on Wednesday, further increasing investor caution in entering the market.

Weak demand for five-year auction, U.S. Treasury yields continue to rise

U.S. Treasury bonds are the core driving force behind the current global bond market adjustment. On Thursday, U.S. Treasury yields continued to rise, with the 10-year yield increasing by 2 basis points to 5.14%, a new high since 2007, while the 30-year yield rose to its highest level since 2004.

The U.S. Treasury completed a $70 billion five-year Treasury bond auction on Wednesday, with the winning yield reaching the highest level since 2006. According to a measure used by Bloomberg, the performance of this auction ranked as the second worst since records began in 2018, indicating that the market still demands extra compensation at higher yield levels. As the size of U.S. debt approaches $40 trillion, the continuously rising interest expenses have further amplified concerns about the fiscal situation.

Both strategists from JPMorgan and KKR expect that U.S. Treasury yields still have room to rise further and view energy-driven inflation, massive government borrowing, and the risks of further tightening by the central bank as the primary driving factors. Bloomberg Markets Live strategist Alyce Andres stated that the selling of Treasury bonds by investors is not due to a collapse in inflation credibility, but rather because the real policy outlook and term premiums still require larger concessions.

Sell-off spreads to Asia, Japanese yields hit 30-year high

The pressure in the bond market further spread to the Asian markets on Thursday. The yield on Australian three-year government bonds jumped by 14 basis points, reaching 5.07%, the highest since May 2011; New Zealand’s two-year yield rose by as much as 17 basis points, nearing 4%.

After a three-day holiday, the Japanese market reopened and quickly caught up with the global sell-off, with the 10-year Japanese government bond yield rising to its highest level since 1996. Carol Lye, a portfolio manager at Brandywine Global Investment Management, stated that local demand from pension funds, banks, and life insurance companies for the Japanese government bond market remains insufficient.

The adjustment in the global bond market also reflects a certain degree of market repricing of the interest rate environment. According to Bloomberg index data, global government bonds have accumulated a decline of about 2.4% this year, compared to an increase of 6.8% during the same period last year, indicating that the pressure on the bond market has significantly increased.

High inflation and high fiscal demand support high yields, investors await volatility to cool

Reports cite market participants who believe that the current bond sell-off has certain fundamental support. Amy Xie Patrick, a fund manager at Pendal Group, stated that inflation remains high and sticky across multiple economies, with a tight labor market; even as fuel and various commodity prices rise, the economy continues to maintain good growth. Against this backdrop, bond performance aligns with current economic fundamentals.

In the face of ongoing sell-offs, investor strategies are diverging. Damien Loh, Chief Investment Officer at Ericsenz Capital, believes that short-term bond valuations have appeared cheap, but he does not recommend immediate contrarian entry; for investors looking for opportunities from the sell-off, he is more inclined toward steepening yield curve trades, such as the 2-year/10-year or 5-year/30-year spread strategies, believing that their risk-reward ratios are more reasonable.

TD Securities strategist Hans Mikkelsen pointed out that the current contradiction in the fixed-income market is that investors want higher yields, yet do not want yields to continue rising rapidly. "They are afraid of catching a falling knife." The continuously rising volatility in the bond market has become a major barrier for potential buyers who are reluctant to enter.