Rising bond yields - what do they mean for investors?
Rising US Treasury yields have become an important topic for investors in recent weeks. Higher yields affect everything from government borrowing costs to equity valuations. Investors are therefore asking what is driving the move, whether policymakers can intervene and what it means for bond markets going forward.
What is driving higher yields?
US Treasury yields have risen significantly since July. While energy-driven inflation concerns played a role earlier in the year, recent moves appear to be driven mainly by concerns about the US fiscal outlook.
The US government continues to run large budget deficits, which means substantial amounts of new Treasury bonds need to be issued. Investors are demanding higher yields to absorb this growing supply. At the same time, uncertainty around the Federal Reserve's policy approach and strong issuance competition from companies financing AI-related investments have added to market nervousness.
Can the US Treasury stop yields from rising?
The US Treasury recently announced measures aimed at supporting the long end of the bond market, including larger buyback operations for longer-dated government bonds.
While these measures can provide temporary support, they are small compared with the scale of new government borrowing. As a result, they are unlikely to fundamentally change the direction of the market unless the underlying fiscal situation improves.
And what about Europe?
Given the size and importance of the US Treasury market, developments in the US often spill over into other government bond markets. Furthermore, European bond markets face some of the same challenges. Government bond issuance in the Eurozone is increasing due to investments in defence and the energy transition and other fiscal initiatives. In the past, central banks were important buyers of government bonds and helped keep yields low. Today, a larger share of the market is held by investors who are more sensitive to valuation and risk. As a result, yields are increasingly determined by supply and demand dynamics.
Although term premia, the additional compensation investors require for holding longer-dated bonds, are likely to rise in Europe as well, we expect lower policy rates over time to offset part of that impact.
What does this mean for investors?
We expect term premia to remain under upward pressure. However, this does not necessarily mean bond yields will continue to rise sharply. Our base case remains that inflation pressures will gradually ease and that the Federal Reserve will eventually begin cutting interest rates next year. Lower policy-rate expectations should help offset some of the upward pressure coming from higher term premia.
Furthermore, higher yields are also making bonds increasingly attractive to investors. However, we are not in a hurry to increase exposure to longer-dated bonds. In our view, bond markets are still adjusting to a new equilibrium. While issuance remains elevated, investor demand for bonds has also increased.
Bond yields are most likely to fall sharply in a recession scenario that would force central banks to cut interest rates aggressively. At this stage, we do not see signs that such a scenario is becoming more likely. As a result, while higher yields are improving the appeal of bonds, we believe it remains too early to position for a significant decline in long-term yields.
Therefore, we continue to favour high-quality corporate bonds over government bonds. Corporate balance sheets have generally improved in recent years, while many governments continue to rely on fiscal stimulus and rising debt levels.
Conclusion
The recent rise in bond yields reflects growing concerns about government borrowing and persistent uncertainty around inflation and monetary policy. While the US Treasury has introduced measures to support bond markets, these are unlikely to fully offset longer-term fiscal pressures. We expect that term premia will continue to rise, but eventual rate cuts from central banks should prevent a sustained surge in government bond yields. At the same time, above-trend growth in the US economy should help support the current yield environment.
For investors looking for a more detailed discussion of Treasury markets, policy interventions and our outlook for bond yields, we refer to the full ABN AMRO Group Economics paper Top of Mind - Rising US Treasury Yields Q&A.
Roel Barnhoorn
Head of Fixed Income strategy and Portfolio construction
Nick Kounis
Chief Economist of ABN AMRO