Global interest rates on government bond yields have been rising to decade-highs in recent weeks, with bond markets experiencing a steep global sell-off. The key long-term 10-year US government bond yield rose by nearly 18-bps during the month, reaching 4.975% by last Friday (11th of September), its highest since late 2023 and sitting just below the critical 5% line. At the same time, the benchmark 10-year yields for G7 economies have risen by an average of 19-bps over the last week, marking their worst sell-off since the start of the Iran war. The UK benchmark rate rose by 21.29-bps, while Japan’s rose by 7.7-bps, reaching an all-time high. In the EU market, Germany’s 10-year yield rose to 3.50%, its highest since 2011, while the French 10-year yield reached its highest since 2008 to roughly 4.46%.
What are main reasons for US bond yields to rise?
The sudden escalation in the Middle East conflict over the last two weeks has caused oil prices to jump back above USD 100 per barrel, renewing inflation concerns in the US and the rest of the world. Investors usually tend to demand higher interest rates or yield margins on government bonds when inflation expectations are high. This has been one of the biggest factors behind the continuous pickup in bond yields over the past month. At the same time, the annual US government budget deficit and debt have been rising, with the budget deficit expected to top USD 2 trillion by the end of this year and US debt surpassing USD 40 trillion for the first time ever. With the government issuing more debt, investors are less likely to take on the debt for a lower return, which pushes yields higher. Further, large tech and AI firms are also borrowing more as the AI boom picks up and with large private firms such as Google and Amazon are willing to pay higher rates, creating further pressure on the US government to increase its rates.
Are other financial markets facing the same issue?
Financial market players in the euro area are also bracing for interest rate hikes well into next year, as the European Central Bank has hiked borrowing costs and increased its inflation forecast, just as oil prices jumped again due to the Iran war, with bond yields hitting multi-year highs.
On Thursday, the UK 10-year gilt yield jumped by 10 basis points to 5.378%, its highest since July 2007, a level last seen on the eve of the global financial crisis. This has added further pressure on the new finance minister, John Healey, ahead of his first annual budget statement next month. According to Susannah Streeter, chief investment strategist at Wealth Club, “steamy energy prices” appear to be the biggest trigger for these latest yield rate movements. She also adds that a structural shift among borrowers away from US Treasuries towards corporate debt in search of higher returns has also been a factor behind the rise in global government bond yields.
On the other hand, Japan’s 10-year yield peaked at 3% last week for the first time since 1996, mainly as a result of concerns over inflation and fiscal spending, together with expectations that the Bank of Japan will raise rates more quickly. The milestone coincided with a 4% rally in the yen this month and growing speculation that the Government Pension Investment Fund (GPIF) could eventually increase its allocation to domestic bonds.
How will this affect policy rate changes?
The Chicago Mercantile Exchange noted that the odds of the Federal Reserve raising its key policy rate by a quarter percentage point during this week shot up to about 86%, from the previously held 72% chance last Thursday. However, the global bond market took a slight breather last Friday after the widely anticipated US inflation report met economists’ expectations, pushing up the odds of a Fed “wait-and-see” approach.
The European Central Bank also voted to raise its key deposit rate by 25 basis points, from 2.25% to 2.5%, due to the uncertain outlook surrounding the continuation of the US-Iran war and its impact on inflation. Investment strategists said the decision indicates that further rate rises are now likely.
What does this mean for Sri Lanka and other emerging markets?
The rise in global government bond yields could create renewed pressure on emerging markets, including Sri Lanka, particularly if higher yields persist. Rising US Treasury yields make developed-market assets more attractive to global investors, potentially reducing capital flows towards emerging markets as investors demand higher returns to compensate for increased risk. This could put pressure on emerging market currencies, bond yields and external financing conditions.
For Sri Lanka, higher global yields could increase the cost of external borrowing if the country it to look at it somewhere in the future. At the same time, renewed inflation concerns and oil prices above USD 100 per barrel could increase the import bill and put pressure on the current account and inflation. However, Sri Lanka is better positioned than during the 2022 crisis, with stronger reserves, improved external balances and ongoing IMF-supported reforms providing greater buffers.