After two consecutive years of losses (prices move in the opposite direction to yields) bond investors were relatively optimistic at the start of 2023. Sadly, that optimism was misplaced with the real prospect of an historic third consecutive year of losses in the cards.

Since the US 10-year treasury yield bottomed in August 2020 at 0.5% prices have fallen 31% while the yield is now above 5% for the first time since the eve of the financial crisis in 2007, likewise with the yield on 30-year treasuries. Meanwhile the UK 30-year gilt yield recently breached 5% which is the highest level since 1997.

US bond markets play an important role in global capital markets and set the global cost of capital. The Middle East conflict could be having impact on bond yields through the oil price which has risen because of potential risks to supply.

Higher oil prices eventually feed through to higher inflation which pressures central banks to keep interest rates higher for longer. Another important driver is the US economy which has been more resilient than many economists were expecting at the start of the year.

In other words, bond markets have had to adjust to the reality that a recession is not happening in 2023 and bets that the Federal Reserve would be cutting rates early in 2024 are now off the table.

Ronald Temple, chief market strategist at Lazard points out that consensus expectations for the advanced reading of third quarter GDP is an annualised 4.3%, up from 2.1% in the prior quarter.

A healthy economy could be framed as a positive reason for higher bond yields. The prevailing assumption here is that when the effects of monetary tightening feed into the economy, bond yields will fall back. But there could be a less benign explanation driving yields higher. This relates to concerns over the ballooning US fiscal deficit.

It could be that bond investors are baulking at the sizable government debt issuance which lies ahead. Adding to the angst is the Fed’s QT (quantitative tightening) policy which effectively means it is now a seller of bonds rather than buyer under its prior QE (quantitative easing) policy.

How long the current bond ‘buyers strike’ will last and how high yields could go is anybody’s guess, even if there was a temporary hiatus in bond selling on 23 and 24 October.

But one thing is for sure, the higher yields rise, the more financial pain will be inflicted. US annual debt interest payments are running close to $1 trillion, while the government needs to refinance up to $17 trillion of its existing $33 trillion of debt in the next two years.

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