U.S., U.K. and French budget woes combine to trigger worldwide bond market rout

Long-term Treasury yields are close to 5% as international peers surge - Getty Images/iStockphoto

Surging long-term government bond yields are causing consternation across financial markets on Tuesday. A trifecta of separate themes are converging to focus investors on the rising cost of government debt amid unsustainable budget deficits.

Last week the crisis was the sell-off in French bonds BX:TMBMKFR-10Y – called OATS –  after a confidence vote on the government was called for Sept. 8, prompting a sharp fall in the CAC 40 FCE00 share index on fears of a political vacuum. The spillover from this volatility has triggered similar declines in German BX:TMBMKDE-10Y and Dutch government bonds BX:TMBMKNL-10Y , now also trading with yields at fourteen-year highs.

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This week, the alarm bells are ringing in the U.K. as 30-year bonds BX:TMBMKGB-30Y – known as gilts – continue their inexorable decline as the Labour government tries to plug a £20 billion to 25 billion fiscal hole during its upcoming autumn budget.

Meanwhile, U.S. 30-year yields BX:TMUBMUSD30Y have moved back up toward 5% as courts declare trade tariffs illegal, calling into question the hundreds of billions of dollars of revenue generated since their imposition in April.

Deutsche Bank’s head of macro and thematic research, Jim Reid summarized the predicament in which the U.K. government finds itself as a “slow-moving vicious circle: rising debt concerns push yields higher, worsening debt dynamics, which in turn push yields higher again.”

Thirty-year gilt yields reached 5.68% in Tuesday trading, the highest since 1998, and the lack of confidence in the government’s ability to stabilize its finances is reflected by a 1% slump in sterling against the dollar overnight.

Panmure Liberum’s head of research Simon French pointed out that ”long-end yields are rising around the world amidst a structural shift in demand” but nevertheless “the U.K. is experiencing asymmetric inflation right now that means investors are demanding high compensation to hold U.K. debt.”U.K. inflation trends are decoupling from the G20 median - Panmure Liberum

French emphasizes that while rising term risk premia – the additional return investors demand for the risks of holding instruments of longer duration – are a feature of most global bond markets at present, the U.K.’s case is severe. Its 10-year benchmark bonds BX:TMBMKGB-10Y trade 50 basis points higher than the rest of G7, for instance.

Roger Lee, equity strategist at Cavendish Securities, published a note last Friday, titled “Technology that doesn’t work” in which he highlighted the views of former Bank of England monetary policy committee members, Willem Buiter and Andrew Sentance, who both forecast a “U.K. fiscal event ( read crisis) sometime in late 2025 or 2026.”

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Michael Brown, senior research strategist at Pepperstone in a note on Tuesday considered the situation so serious that he suggested sales of long-term gilts should be suspended in order to relieve upward pressure on bond yields.

U.S. markets were closed Monday for the Labor Day holiday but traders will be returning to contemplate rising bond yields in their own backyard too.

At 4.97%, the 30-year bond yield is within spitting distance of the key 5.00% level. The U.S yield curve is steepening with the spread between 2 and 30-year bonds now 130 basis points, suggesting that inflationary expectations are becoming unanchored.

While some of this move is no doubt in sympathy with the global trend, there is growing idiosyncratic risk after a U.S. court declared President Trump’s tariff policies illegalwhile the row over central bank independence is coming to the boil.

A note published Tuesday by Deutsche Bank’s global head of forex research, George Saravelos, examined to what extent markets are adequately discounting the looming crisis over Fed independence. In the note, titled “Complacent”, he stresses that “The problem will come if the data changes and the Fed keeps cutting.”

He reckons the market is currently not pricing in any long-term shift in the Fed’s reaction function around inflation. The weaker dollar is merely tracking the dovish repricing in rates on the back of recent weak economic data, and the absence of a risk premium is consistent with the lack of movement in long-term inflation expectations.

He cites historical precedents to demonstrate what happens when the Fed cuts “too much” and the result was ominous.

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