What's driving the bond market sell-off?
Longer-term yields are belatedly catching up with expectations for central bank hikes
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When markets make sudden moves, as with the spike in long-term government bond yields this week, there’s never any shortage of ex post rationalizations on what drove the move. The problem is that most of these rationalizations don’t count as catalysts because they’ve been known for a long time, so they’re hardly “new.” For example, it’s clear that fiscal policy across many advanced economies is on an unsustainable track, but that’s been true for many years. It’s also true that the rise in oil prices is going to push up inflation, but - again - that can hardly be counted as new information.
I think what’s happening is simpler. There’s been a disconnect in yield curves, with front-end yields pricing central bank hikes, while long-term yields stayed anchored. This disconnect was very unusual. Ordinarily, expectations for central bank hikes drive yields up across the curve, as was the case during the post-COVID inflation shock. As the closure of the Strait of Hormuz drags on - with no end in sight - this disconnect became increasingly unsustainable and so - this week - we’re seeing a catch-up in longer-term yields to what short-term rates have priced for a while.
The underlying driver in all this is the length of Strait of Hormuz closure. If by some miracle we see a peace deal and oil tanker traffic through the Strait normalizes, short- and long-term yields will fall quickly. So it’s not like further increases in long-term yields are preordained. But if the status quo drags on, long-term yields have more catching up to do. This week’s long-term yield spike is therefore about markets capitulating on the idea that this conflict gets resolved soon.
Each of the charts above shows the central bank’s policy rate (black), what futures price for the policy rate by the end of 2026 (blue), the 10-year government bond yield (orange) and the 30-year government bond yield (red). I show the US (top left), the UK (top middle), Canada (top right), Germany (bottom left), Switzerland (bottom middle) and Australia (bottom right). My basic point is easy to see in the chart for the US. In the 2022 - 2024 period, changes in market pricing for the Fed quickly spilled over into 10- and 30-year yields. The blue, orange and red lines basically move in synch. That hasn’t been the case recently and that’s what the spike in long-term yields is now correcting. To varying degrees, this is true also for the other countries shown.
Of course, as I laid out in a post yesterday afternoon, there’s more to the current bond market sell-off than just this. Central banks have been holding down long-term yields in some places. Ground zero for this is Japan, but the ECB is doing this too for high-debt countries on the Euro periphery. This is a separate, structural force for long-term yields to rise, which is why this week’s sell-off is radiating out from Japan.
Hey Robin, good timing on these posts. I just read a good Japan explainer by Elias Rutten which raised my alarm levels. You don't seem as worried about Japan, despite shaking your head at their policy blunders, because you say they have lots of assets they can sell. But what would this do to US treasuries? Are you worried about a wave of selloffs accelerating if Japan follows your advice and pulls the trigger on foreign asset sales?
The Hormuz catch-up explains this week, but there's a second anchor on long rates that won't resolve with a peace deal. Tech firms are committing tens of billions to AI infrastructure this year (Meta alone reportedly approaching fifty billion in capex), and that spending lands in the real economy as demand for energy, construction, and chips. If long-term yields were suppressed against both Hormuz and the largest corporate capex cycle in decades, the correction has further to run even in the optimistic scenario.