The bond market came under pressure, with 10-year yields in the US, Japan, UK, and Germany hitting multi-year highs amid little progress in geopolitics, to say the least.
It’s been more than two months since the US and Iran agreed to end the war, but the Strait of Hormuz remains a risky spot. There’s also still no clear end in sight for the Russia-Ukraine war.
And it’s not just about higher oil prices; refined products such as diesel are also getting more expensive, putting pressure on trucking, agriculture, and industry. Natural gas prices are under pressure too, while wheat has jumped amid the attacks in the Black Sea.
Trade wars are also adding to inflation concerns, with Canada preparing 15%–50% tariffs on US imports from September 8 unless Trump pulls another TACO.
Hence, markets are pricing at higher rates, much like central banks themselves. That’s also feeding into currency markets, with the Dollar Index reflecting shifting expectations around US rates and the dollar’s relative strength.
For example, Fed Chair Kevin Warsh said at Jackson Hole that inflation isn’t cooling as expected, and action could follow if there’s no progress. And with the US economy still relatively strong and the labor market close to full employment, the Fed has room to do so.
The problem is that Warsh has promised since taking office to bring inflation back to target without compromising the Fed’s mandate, but so far little has changed.
As for the ECB, Christine Lagarde hasn’t ruled out a September hike, Philip Lane sees inflation rising above 3% by year-end, and Isabel Schnabel says rates may need to go higher if the economy remains resilient.
Then there’s the Bank of Japan, which has reason to consider a September rate hike after Tokyo inflation rose to a five-month high of 1.9% YoY. That shift in rate expectations is also being reflected in USDJPY, where the yen remains particularly sensitive to changes in the BoJ–Fed rate differential.
But inflation isn’t the only problem pushing yields up. Fiscal problems are also playing a role, especially in Europe, with France’s public debt rising from 114% of GDP in 2020 to 117% in 2026, the deficit above 5%, spending outpacing revenues, and debt servicing becoming increasingly expensive. Italy also has a huge debt burden at around 139% of GDP, although its fiscal position is in better shape.
In the US, tax cuts and high government spending have pushed federal debt above $40 trillion, making interest payments the second-largest budget item after healthcare and Social Security.
What’s the problem with higher bond yields?
Rising yields increase borrowing and refinancing costs, putting pressure on public finances and making it more expensive for companies to borrow. Some can absorb higher costs, but others can’t. On top of that, if bonds offer better returns than stocks, some money could shift from equities into fixed income.