The surge in energy costs is driving inflation higher, while the artificial intelligence (AI) boom is boosting economic growth. Together, these forces are prompting investors to position themselves for an era of "higher for longer" interest rates, dealing a severe blow to global bond markets.
The world's largest sovereign bond market is on track for its worst month in years. The policy-sensitive two-year U.S. Treasury yield has soared nearly 60 basis points in September, heading for its biggest monthly gain since early 2023. The ten-year U.S. Treasury yield has climbed roughly 50 basis points this month — also set for its largest monthly increase since 2022 — having now breached 5% and reached its highest level since 2007. Meanwhile, two-year government bond yields in France, Germany, the U.K., and Australia are all poised for their biggest monthly gains since March, while Japanese government bond yields hover near multi-decade highs. Kenneth Broux, Head of Corporate Research for FX and Rates at Societe Generale, said: "The market has realized that the whole energy issue and inflation problem will not disappear in the very short term. The bond market is adjusting to that."
For some investors, rising yields have once again made government bonds attractive. But given concerns about heavy government indebtedness, others remain cautious about longer-dated bonds. Global bond markets face a fresh series of tests in October, including the latest U.S. employment and inflation data, French budget negotiations, the U.K. budget, and potentially further bond issuance from technology companies.
Higher Rates Persist for Longer
Sovereign bond markets matter because they influence borrowing costs for businesses and consumers, such as mortgages. If borrowing costs rise too quickly, it could threaten financial and economic stability, which is why governments and central banks pay close attention. Compared with 2022 — the worst year on record for bond returns — what unsettles the market now is not just the speed of rate moves but the absolute level at which global rates already sit and continue to climb. The ICE BofA MOVE Index, which measures bond market volatility, has surged nearly 30% in September, its biggest jump since March. This expected continued volatility has caught some investors off guard.
Still, some investors are sensing opportunity. Florian Ielpo, Head of Macro and Multi-Asset Portfolio Management at Lombard Odier Investment Managers, said that given elevated yields, his stance on government bonds has turned more positive. He expects government borrowing costs to remain high for some time, as markets must also compete with bond issuance from major technology companies to raise funds for AI investment. According to London Stock Exchange Group (LSEG) data, bond issuance by hyperscalers has more than doubled this year, exceeding $200 billion. Deal-makers also say they can accept financing costs currently at their highest levels since the global financial crisis. Jeffrey Perlman, CEO of Warburg Pincus, said at a conference in Singapore on Tuesday: "A 5% ten-year U.S. Treasury yield is not particularly high by historical standards. Deals can still work at a 5% yield."
Challenges Lie Ahead
In Europe, however, French budget negotiations and the first budget from new U.K. Chancellor John Healey may keep the fiscal troubles of major economies in the market spotlight. Political tensions in France have further fueled dramatic bond market volatility. The country's ten-year government bond yield has surged more than 50 basis points this month, the largest monthly gain since 2022, pushing the spread between French and German government bond yields to its widest level since 2012. Andrzej Szczepaniak, Senior Europe Economist at Nomura, said: "Now France faces an additional idiosyncratic risk. People are starting to wonder, where is the budget? Will there be no budget at all? What happens next? On top of that, (far-left presidential candidate) Melenchon's poll numbers are rising."
In the U.S., although the September rate hike enhanced the Federal Reserve's credibility in fighting inflation, market attention remains focused on uncertainty over the economic outlook and what the Treasury Department will do next to curb rising borrowing costs. Arun Sai, Senior Multi-Asset Strategist at Pictet Asset Management, said: "Policy uncertainty is coming at us from two places — the Fed and the Treasury — and I am very uneasy about the U.S. policy mix."
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