(Bloomberg) — Bonds are falling around the world as investors ponder the prospect of slower rate cuts in the U.S., a trend that risks putting debt positions everywhere at risk.
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Government bonds extended Monday’s sharp losses, with the 10-year yield rising above 4.20% for the first time since July. Yields on equivalent German securities rose by four basis points, reaching their highest level since early September. The rout spread to Asia, where Australian benchmark bond yields rose as much as 16 basis points.
At the heart of the sell-off lies a reassessment of the prospects for US monetary policy. Traders are lowering their bets on aggressive easing as the U.S. economy remains robust and Fed officials sounded a cautious tone this week on the pace of future rate cuts. Rising oil prices and the prospect of wider budget deficits after the upcoming US presidential elections only exacerbate market concerns.
“With the US election less than two weeks away, concerns about the budget outlook and potential upward pressure on inflation have become more acute,” said Robert Dishner, senior portfolio manager at Neuberger Berman in London.
The US 10-year yield rose two basis points to 4.22%, adding to a rise of more than 10 basis points on Monday. The move steepened a key part of the US yield curve, which has been inverted since late 2022, with the gap between three-month and 10-year yields reaching the narrowest level in almost two years.
“We’ll probably see 4.5% early next year” for the U.S. 10-year yield, Ed Yardeni, founder of Yardeni Research, said in an interview on Bloomberg Television.
Traders have trimmed the size of the Fed’s rate cuts through September 2025 by more than 10 basis points since late last week, according to swap prices, which imply a Fed target rate between 3.50% and 3.75%.
Apollo Management is among those who see the central bank possibly keeping rates unchanged at its next meeting, while T. Rowe Price sees US 10-year yields rising to 5% next year on the risk of smaller rate cuts and as growth improves .
What Bloomberg Strategists Say…
“Governments may struggle in the coming months, with a strong upward trend for yields as the US economy remains resilient and supply concerns increase.”
Garfield Reynolds, Markets Live Strategist
The outlook is also being revised in other markets. Swaps indicate the Reserve Bank of Australia will cut rates by only about 50 basis points until the end of August next year, half of what was priced in after the September policy meeting. Similarly, traders pushed their forecast for the Bank of Japan’s next rate hike to June, up from later than July last month.
Demand for long-term investments in Japanese 10-year bonds, “which carry relatively high interest rate risk, is likely to be muted in this environment,” said Keisuke Tsuruta, a senior fixed income strategist at Mitsubishi UFJ Morgan Stanley Securities Co. in Tokyo, wrote in a research note.
Emerging market bonds also fell, with Indonesia’s five-year yield rising seven basis points.
Not everyone expects the sell-off to gain momentum. The Fed and the Reserve Bank of New Zealand, among others, are in the midst of rate-cutting cycles, which should generate an underlying bid for bonds.
“From here on out, we’re likely to see a slight correction,” said Lucinda Haremza, vice president of fixed income sales at Mizuho Securities in Singapore. There is “the risk of a stronger rally due to rising tensions in the Middle East or a Harris election victory,” she said.
For now, however, the combination of US debt supply, election hedging and markets leading the risks of a Republican red sweep at the polls could lead to bigger-than-normal swings in Treasury yields. Treasury volatility has risen to its highest level this year, based on the ICE BofA Move Index, which tracks expected moves in U.S. interest rates based on options.
BlackRock Investment Institute is one of the underweight government bonds with a shorter duration.
“We don’t think the Fed will cut rates as sharply as markets expect,” firm strategists including Wei Li wrote in a note. An aging workforce, persistent budget deficits and the impact of structural shifts such as geopolitical fragmentation should “keep inflation and policy rates higher over the medium term,” they wrote.
–With help from Haslinda Amin, Anchalee Worrachate and Alice Gledhill.
(Prices updated, additional investor voice in paragraph four.)
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