Some Thoughts on the Recent Bond Woes

The global bond selloff is certainly getting plenty of attention from investors, whether or not they normally focus on fixed income.  I’ve certainly received more questions about the recent rise in yields than anything else in recent days.  It’s not a the easiest topic to parse because there isn’t a single cause for the moves, but the explanations include:

• Perceptions of a slower path of rate cuts, especially in the US:  Investors have been pricing in fewer rate cuts from the Federal Reserve, especially around the December FOMC meeting.  After the November meeting there were 4 cuts (of 25 basis points each) expected for 2025.  That was down to two by December, and after Friday’s employment report we are only pricing in somewhere between one and two.  If we take out 3 x 25bp cuts from the pricing, that’s 75bp, which could explain a good portion of the rise in rates in the US.  And we have also seen rate cuts expectations fall in the UK and Europe.

• Fears of higher issuance, particularly in the UK and perhaps the US:  UK Gilts are around levels that reflected the Liz Truss crisis, and while that was a bit of a shock, the current move also involves fears of big deficits.  In the US, it is not clear whether Elon Musk and “DOGE” will be able to deliver the spending cuts that they originally touted, while simultaneously the new administration seems committed to further tax cuts.  A big “tell” occurred during the government shutdown talks of a few weeks ago – they temporarily unraveled after a last-minute demand to eliminate the debt ceiling.  A new administration that is serious about fiscal responsibility would not make that demand, and thus it is probably not a coincidence that rates took another leg higher after that negotiation.

• Inflation fears, particularly if a tariff war breaks out:  A unilateral set of tariffs might raise prices in the US; retaliation from other countries, particularly if it can be termed a “tariff war” might raise prices everywhere

• Potential changes to the composition of US debt issuance: The nominee for head of the Council of Economic Advisers, Dr. Stephen Miran, wrote a paper with Nouriel Roubini earlier this year asserting that the Yellin Treasury is artificially keeping rates low by favoring short-term issuance.  (My colleague Jose Torres hosted an IBKR Podcast on this topic with Drs. Miran and Roubini in August – I was fortunate to participate.)  I believe that Treasury Secretary nominee Scott Bessent agrees with Miran.  If the market believes that there is a realistic chance for proportionally more long-term note and bond issuance, it could explain the steepening of the US yield curve.

• Momentum: Bonds tend to move in trends that last for months at a time.  That said, this one is relatively steep and global, rather than being focused on one area.  But to some extent, if the US sets a big trend, the rest of the world often follows.

• The big exception: China: Quite frankly, if conditions in China sink sufficiently and they export deflation and economic weakness, that could offset some of the concerns we see elsewhere.

A popular follow up to the “why?” of the bond selloff is the “when?”, specifically how long will this persist.  My thoughts here include:

• The real test comes next week, shortly after the Inauguration, when a big wave of executive orders about tariffs and immigration restriction are expected.  If those are perceived as being inflationary or having negative ramifications for the budget deficit, then the rout is likely to continue.  But if they are relatively modest, then we could see bonds stabilize or even improve in a potential “sell the rumor, buy the news” type of event. 

• And even though U.S. fiscal policy has little direct effect on the rest of the world, if US borrowing needs are perceived to ease then that could ease concerns in other markets like the UK.  And of course, if we can avoid a wave of global tariffs, that would certainly help.  

• And another wild card is certainly China.  If their stimulus appears to be getting some traction, some of the money flowing into Chinese debt might flow elsewhere.  

• If we don’t get good news after the inauguration, however, then the timing becomes much more complicated.  It would depend more on price than time, meaning that yields reach some level – say, 5% on the U.S. 10-year – when investors decide that the selling has gone too far.  

It is important to keep in mind that rising rates are not always a bad sign for stocks, as long as they’re predicated upon a strengthening economy.  While many investors have become conditioned to hope for rate cuts over a stronger economy, if not outright liquidity addicts, I will assert that stocks rose in 2024 because we had fewer than the 7-8 cuts that were expected at this time last year.  The economy simply didn’t require aggressive rate cutting, and instead was strong enough to spur earnings – the true driver of stock prices.  But if the rates are rising for other reasons – inflation fears, concerns about over-issuance, etc. – then those do eventually weigh on sentiment and stock prices.  Let’s be careful what we wish for.