The world's biggest sovereign bond markets are headed for their worst monthly performance in years, with rising energy costs stoking inflation and an artificial intelligence boom pushing economic growth higher, prompting investors to brace for an era in which interest rates will remain high for longer.
Two-year US Treasury bond yields rose by about 60 basis points in September, on track to record their largest monthly rise since early 2026, according to Reuters.
Two-year borrowing costs in France, Germany, Britain and Australia are also on track to record their largest monthly rises since March, when the war with Iran broke out and caused a new shock in energy markets. In Japan, government bond yields stabilized near their highest levels in several decades.
“There is a realization that the energy crisis and inflation will not go away in the very short term,” said Kenneth Brough, head of currency and corporate interest rates research at Société Générale. “Bond markets are adjusting to that.”
For some investors, rising yields have made government bonds more attractive again, while others remain cautious towards longer-term bonds due to concerns about rising levels of government debt.
October brings new tests for the markets, with the release of the latest jobs and inflation data in the United States, the French budget negotiations, and the British budget, in addition to expectations of an increase in bond issuances from technology companies.
Higher interest rates for a longer period
Sovereign bond markets are important because they influence the cost of loans to businesses and consumers, including mortgages. If its borrowing costs rise too quickly, this could threaten financial and economic stability, making it the subject of close monitoring by governments and central banks.
Compared to 2022, which recorded the worst bond performance ever, what worries markets this time is not limited to the speed of rising yields; It also includes the high and increasing levels of global interest rates.
Data released last week showed that the interest rate on the most common American home loans rose to its highest level in more than two years.
US 10-year Treasury bond yields also rose to more than 5 percent for the first time since 2007, and are on track to record the largest monthly rise since 2022, with an increase of nearly 50 basis points.
The Ice Bank of America MOVE index, which measures bond market volatility, jumped about 30 percent during September, its largest increase since March. This volatility, which is expected to continue, has surprised some investors, while others see it as an opportunity.
Florian Ilbo, head of macroeconomics and multi-asset portfolio manager at Lombard Odier Investment Managers, said he has become more optimistic towards government bonds, driven by rising yields.
Ilbo expects government borrowing costs to remain high for some time, as bond issues from major technology companies compete for the liquidity needed to finance artificial intelligence investments.
Data from the London Stock Exchange Group (LCEG) showed that the value of bond issuances from giant cloud computing companies, known as “hyperscalers,” more than doubled this year to exceed $200 billion.
Those in charge of financing deals say that they are also able to bear financing costs that are the highest since the global financial crisis.
“5 percent is not very high by historical standards,” Warburg Pincus CEO Jeffrey Perelman said during a conference in Singapore on Tuesday. Transactions can be executed at a 5 percent yield for 10-year bonds.
Challenges loom on the horizon
In Europe, French budget negotiations and the first budget of new British Finance Minister John Healey are likely to keep fiscal problems in major economies under the microscope.
Political tensions in France exacerbated the striking movements in the bond market. The French 10-year bond yield rose by more than 50 basis points this month, in the largest monthly move since 2022, pushing the spread between it and the German bond yield to its widest level since 2012.
“We now have risks specific to France, and investors are asking: Where is the budget?” said Andrzej Szczepaniak, chief European economist at Nomura. Will there be a budget at all? And what will happen? “And (hard-left presidential candidate Jean-Luc) Mélenchon is now gaining popularity in opinion polls.”
In the United States, although the September interest rate hike strengthened the Federal Reserve's credibility in fighting inflation, uncertainty about the outlook and next steps of the Treasury Department, which has taken some measures to limit borrowing costs, has been in focus.
“Policy uncertainty comes to us from two sources,” said Arun Sai, chief multi-asset strategist at Pictet Asset Management. "The Federal Reserve and the Treasury Department, and I am very concerned about the mix of American policies."
The sell-off in euro zone bonds stopped on Tuesday, with yields falling from their highest levels in years, but remaining near high levels, on expectations that strong growth and rising energy costs will push global interest rates higher.
The 10-year German government bond yield, the euro zone's benchmark, fell by two basis points to 3.625 percent, after rising on Monday to 3.6526 percent, its highest level in 17 years. Bond yields move in the opposite direction to their prices, according to Reuters.
The benchmark yield in the euro zone recorded its first decline in six sessions, at a time when oil and gas prices are still the main driver of the bond market, amid fears that inflation caused by high energy costs will push the European Central Bank to continue raising interest rates.
European Central Bank President Christine Lagarde said that the bank believes that adopting a deliberate and calculated response is the most appropriate option to control inflation. She added that developments in the bond market, especially rising long-term yields, may lead to a slowdown in economic growth.
“We estimate that this means one or two additional increases in interest rates from this stage,” Danske Bank economist Olavi Kaskesaari said.
He added: “This also means that the European Central Bank is in no hurry to raise interest rates again, which reduces the possibility of the next increase in October.”
Financial markets are currently pricing in four additional interest rate increases, at a quarter of a percentage point for each increase, in addition to the two increases approved over the summer.
The two-year German bond yield, which is most sensitive to changes in the European Central Bank's interest rate expectations, also fell by about two basis points to 3.281 percent, after hitting its highest level in three years the previous day.
