Stock markets continue pushing higher, but a warning signal is flashing in the background: government bond yields are surging across the world. In this analysis, we explore why rising borrowing costs could become a major threat to equities, how inflation and energy shortages are driving bond markets higher, and why investors should not ignore mounting macroeconomic risks.
Bond yields blast off
While the major US-China Summit was held last week amidst great fanfare, an equally important event was taking place in the global financial market.Â
That was the strong breakout in government bond yields.Â
Perhaps overshadowed by the all-out party in memory stocks, fast-expanding AI and those forthcoming gargantuan IPOs (SpaceX, OpenAI), the surge in medium-to-long term bond yields was less noted. But, I suspect developments there will be very significant for the Main Street in the coming months.Â
Let’s take a quick (technical) look at some of the yield charts to see what the fuss is all about.
US 10-year bond yield: Surged through the 4.5% key level last week. The next target for the rally is near the 4.8% peak established back in 2024.
US 30-year bond yield: Is on the brink of taking out the cyclical peak at 5.15%. If successful, this yield will sit at the highest level in nearly two decades. Given the firm pattern of rising lows, chances of a further rally here are high.
UK 10-year yield: Touched new multi-decade highs last week. Whilst the rate seems hesitant at around 5%, its long-term trend is bullish, especially as a new leadership contest is taking place to choose the sixth UK PM in a decade.
As a comparison, the Greek 10-year yield is currently at 3.8%, while the Italian 10-year is 3.9%.
EU 10-year bond yield: Breached the critical 3% this year to the upside. Technically, momentum here remains positive, especially as there is no clear resistance until 3.5%. Firm support observed at 2%.
Japan 10-year yield: The rally here is by far the strongest – and most consistent amongst developed markets. From negative levels during Covid, the yield is vaulting towards 3%. But the rally here feels rather climactic. Rates, like stock prices, can’t progress at this furious pace for long. I anticipate a potential correction over the medium term.
But rampant Wall Street ignores the threat
Advances in government bond yields are becoming ever more powerful. This is worrying.
The last time bond yields surged uncontrollably was back in 2022. Most people would remember what happened next. Economic growth slowed to a trickle; inflation skyrocketed. It took the global economy a good 18 months to adjust to the new rate regime.
Wall Street will find it hard to party on if borrowing rates extend their upward march like this.
The financial weight of borrowing costs increasing from 4% to 6% will be much heavier than the rise from 0% to 2%. In economics, cumulative effects are often not felt fully until the end of a trend. That’s when the market buckles under stress. Refinancing debt, for instance, in the current climate will become quite expensive.
Of course, stock bulls will contend this negative conjecture with these points:
- The fact that S&P/Nasdaq remain near their highs suggests market resilience to higher borrowing costs
- Â Gulf Blockade may be terminated at any time (oil to plummet)
- Market liquidity remains strong and plentiful. Sentiment is highly optimistic (see, eg, SpaceX’s $1.5t valuation!)
So what’s there to worry about?
When will central banks hike rates aggressively?
When I look at those sharply higher yields, one old market adage springs to mind:
Bull markets don’t die of old age. They are killed off by central banks.
Time and again, many great bull markets were terminated by hawkish central banks. In 1989, the Bank of Japan embarked on a series of rate hikes that ended the great Japanese asset bubble. By 2007, the Fed had raised the policy rate 17 times which broke Wall Street investment banks soon after.
But have central banks turned hawkish now? Some are. The Reserve Bank of Australia and Norwegian central bank have increased their policy rates recently. Others like the ECB and BoJ are weighing rate increases, too.
What will kick monetary policymakers into aggressive rate hikes? Higher inflation figures. This should not too difficult to reach due to $100 oil, rising transport and food costs. Real rates (nominal minus inflation rates) are fast dropping into negative territories.
So while it appears central banks are in a ‘wait and see’ mode, thus calming investor nerves, the window of monetary inactivity is shortening. For example, US wholesale producer price index (Apr)Â just hit 6%.
And it is not hard to imagine the price effects of a continuing empty Strait of Hormuz:
- food shortages across Asia -> leading to higher food prices
- global oil stockpiles are dwindling as we head into the summer season -> leading to higher oil prices
- supply risk of critical elements (eg Aluminium or fertilisers) -> higher commodity prices
Conclusion
While US stock markets are nudging ever higher, one should be attuned to macro risk factors that may cause an unexpected correction in Wall Street.
An emerging risk factor now is higher bond yields across major economies.
As long as transport across the Strait of Hormuz is curtailed, global inflation will rise. This, in turn, will coerce central banks to ‘do something’ about it – which is most likely to be rate hikes for the rest of 2026. The bond market is just pricing in this possibility accordingly.
Thus while the outlook from equities is currently sunny and rosy, do not ignore the warning signal from the credit market. And it just flashed amber.
Jackson is a core part of the editorial team at GoodMoneyGuide.com.
With over 15 years of industry experience as a financial analyst, he brings a wealth of knowledge and expertise to our content and readers.
Previously, Jackson was the director of Stockcube Research as Head of Investors Intelligence. This pivotal role involved providing market timing advice and research to some of the world’s largest institutions and hedge funds.
Jackson brings a huge amount of expertise in areas as diverse as global macroeconomic investment strategy, statistical backtesting, asset allocation, and cross-asset research.
Jackson has a PhD in Finance from Durham University and has authored over 200 guides for GoodMoneyGuide.com.
