Yields on 10-year U.S. Treasuries are back at levels last seen in October 2023, even though the Fed has since cut rates from 5.5% to 3.75%. The situation is even worse for 30-year Treasuries, whose yields have surpassed levels last seen 19 years ago. European bond yields are also rising, including in France, Germany, and the UK.
What is driving the yields up?
It’s a combination of factors.
First, investors fear inflation could stay elevated due to disruptions in the Strait of Hormuz. And no wonder, according to Kpler, oil tanker traffic has fallen 64% from its June peak following the U.S.-Iran memorandum of understanding, while diesel prices, so important for farmers, continue to rise.
To avoid monitoring systems, tankers are switching off their transponders and passing through almost unnoticed. That’s one reason oil prices haven’t broken above $100 a barrel, but companies will clearly demand a risk premium for such dangerous logistics.
So consumers will pay not only for more expensive oil, but also for its transportation until the situation in the Middle East improves.
The second reason yields are rising is that investors want a higher premium for long-term government debt as government spending and debt keep rising.
Starting with the U.S., government debt is approaching $40 trillion, while annual interest payments have already exceeded $1.2 trillion, more than the country spends on defense.
As for Europe, according to a recent paper by the IMF, government debt remains high after the pandemic, while spending on an aging population, defense, and the energy transition is rising quickly, and by 2040, these factors could add around 5% of GDP to spending, pushing debt to 130% of GDP without policy changes.
The U.S. also faces the risk that Japan could sell its Treasury holdings to raise cash and support the yen, adding further pressure to USDJPY, which is moving back toward 160 despite joint intervention by the U.S. and Japan.
And there’s one more factor. Growing technology companies are issuing record amounts of corporate debt to finance AI investments, meaning governments are increasingly competing with tech and other companies for the same pool of capital.
The drawback is that higher yields are already pushing up mortgage and corporate borrowing costs, which could eventually hit the U.S. economy and markets. But so far, investors don’t seem too worried.