Behind the huge shock in the global bond market: profound changes in economic structure, high inflation or growth period themes

The Zhitong Finance App learned that the global government bond market experienced a sharp sell-off this week, reflecting investors' deep anxiety: macroeconomic factors continue to drive up inflation, yet fiscal deficits and debt pressure on countries have not abated.

Higher yields are not simply due to increased government borrowing and rising energy prices. Investors are noticing deeper structural changes: globalization is giving way to protectionism, and geopolitical conflicts have spawned tariff barriers, industrial relocation, and military spending expansion. Together, these signals point to a more fundamental reshaping of the economic landscape, which means that inflationary pressure is likely to remain high for a long period of time.

If this is true, it means that the low and relatively stable inflation environment since the global financial crisis has been broken, and the logic of investor portfolio allocation will also be reshaped.

Emma Moriarty, portfolio manager at CG Asset Management, said: “The structural characteristics of the global economy have changed and are now driving inflation rather than deflation.” “Tariffs, and the subsequent outbreak of the Middle East war, are a sharp reflection of this change in order. It is wrong to view the energy shock as a temporary phenomenon because the potential structural changes that triggered it could be quite long-lasting.”

The “gray rhino” of public debt, which has reached a new high in yield, is approaching

This week, US 10-year Treasury yields climbed to their highest level since November 2023; Japan's 10-year Treasury yield hit 3% for the first time since 1996; British 10-year Treasury yields hit a post-2008 high; and German 10-year Treasury yields, which are a trend vane for Eurozone borrowing costs, also rose to the highest level since 2011. These countries' long-term bond yields are also at their highest levels in years or decades.

Jon Cunliffe, head of the investment office at JM Finn, said that although cyclical inflationary pressure may continue to ease, investors should not expect inflation to return to a continuously low and stable state between 2010 and 2020.

Cunliffe said, “The key is whether artificial intelligence can play an anti-inflationary role by significantly increasing productivity — this is certainly what the new Federal Reserve Chairman Walsh wants to see as US policymakers struggle to deal with growing fiscal problems.”

The sharp rise in yield this week, particularly the rapid rise in long-term interest rates, highlights that investors are demanding higher term premiums against the backdrop of increased demand for fiscal borrowing, continued uncertainty about inflation, and weakening central bank support for government bonds in some major economies.

Haig Bathgate, CEO of Callanish Capital, said on Wednesday that while this week's sell-off reflects a degree of short-term fluctuation, continued inflation throughout the yield curve “will be a long-term characteristic of the future market.”

Regarding the “spiraling rise” in public spending, Bathgate warned: “Someday, this will have bad consequences.” He added, “Looking back at the history of the 70s, once the Pandora's box of inflation was opened, it was difficult to close it back. It has continued beyond everyone's expectations.”

Inflation is difficult to reduce, growth is weak, and the central bank's policy path is in a dilemma

With inflation still vulnerable to supply-side shocks and geographical disturbances, and economic growth is weak, central banks face increasingly complex challenges in choosing interest rate paths.

Cunliffe pointed out, “In this context, the Bank of England and the Federal Reserve may tolerate temporary inflationary overruns while closely monitoring whether a second round of wage and price effects will occur. In other regions, however, the ECB and the Bank of Japan are on a more clear path of austerity — the former balances inflation and growth, while the latter promotes monetary policy normalization after both growth and inflation are on a sustainable path.”

After Federal Reserve Chairman Walsh delivered a keynote speech in Jackson Hole, Wyoming on August 28, the market's probability price of a rate hike at the Federal Reserve meeting later this month rose to over 66% from about 35% previously.

Padhraic Garvey, head of regional research for the Americas and head of global interest rate and debt strategy at Dutch International Group, said on Thursday that the situation in Iran and high energy costs are putting additional upward pressure on long-term yields. “This is a real problem that needs to be solved urgently for Europe, Asia and the wider region.”

Brent crude oil, the benchmark for international oil prices, rose more than 1% to 96.64 US dollars per barrel on Thursday, a one-month high; US WTI crude rose 1.6% to 92.52 US dollars/barrel.

Garvey further stated, “If the market stops at this point, the long-term interest rate levels of many issuers seem quite reasonable. The problem is that the market is far from over — multiple factors are intertwined, and most of the pressure still points to an upward trend in long-term interest rates. The current situation is still manageable, but if the situation worsens further, it could turn into a disaster. It's hard to imagine the upward pressure on long-term yields going away on its own.”

Garvey also said that the market's probability pricing of a 25 basis point rate hike at the September meeting of the Federal Reserve has changed from roughly five to five to about 75%.

Are bonds no longer “safe haven”? Investors are recalculating

Surging yields are also reshaping investors' portfolio allocation logic.

John Stopford, head of multi-asset returns at Ninety One, said, “Increased inflation fluctuations tend to increase the correlation between equity and debt, thereby reducing the benefits of risk diversification associated with holding bonds in a balanced portfolio. However, a rise in real interest rates means an increase in the cost of capital, which may increase the relative attractiveness of bonds. In particular, current stock valuations are already at a high level.”

Brian Mangwiro, managing director of Barings' global fixed income team, suggests that government bond funds should adopt a defensive strategy and invest in products with shorter maturities.

“Multi-strategy fixed income funds can also pursue higher returns, but the long-term period should still be short. For the US, sell-off of treasury bonds and steeper yield curves are often accompanied by a weakening of the dollar, which is generally beneficial to emerging markets.”