What is driving the global bond sell-off? You asked, we answered

Question asked by: Anonymous
Question: Would you be able to explain to me (a layman) what has led to this? My understanding is that rates are increasing, which means that the cost of debt is higher? And what would need to happen for rates to come down? Also how does this affect the thinking of central banks?

Answered by: Robin Wigglesworth
Answer: Annoying (or delightfully, depending on your perspective) bond markets can almost be like an ink blot test: because bond yields can go up and down for both "good" and "bad" reasons there's always a temptation to see what we want to see in it.The drivers have also been different in different countries. But VERY broadly speaking, I think the rise has been caused by a mix of:Higher inflation because of the Iran war lifting energy prices; surprisingly strong and resilient global economic growth; greater uncertainty about the long-term level of central bank interest rates; a global savings glut that has probably peaked; and greater demand for capital from the likes of AI hyperscalers.One can argue about the relative importance of all these factors (i'm personally a little bit sceptical that the last one has been a major driver), but they've probably all played a role. Most of all, I think this shows that we are finally exiting the "new normal" era of low growth, low productivity, low inflation and low bond yields, and that's on balance a healthy thing — even if the consequences for very indebted governments could be painful.

Question asked by: Paul Thi
Question: War or fiscal? Giles ranks the Iran war and policy-path repricing first, with fiscal differentiation on top. Do dealers and fund managers agree, or do they talk mostly about supply and term premium?

Answered by: Ian Smith
Answer: You get a range of views. The recent shift higher in long-dated bond yields has many people talking about the term premium and supply, as well as US growth resilience. But the sell-off started with an oil price spike and it is hard to argue that a big part of it was the Feb/March repricing to the front end, with a lot of uncertainty piled into the long end. Long-run inflation expectations have not really moved but the world and the global supply chain are a lot more uncertain than they were at the start of the year.

Question asked by: Badabing
Question: Isn't the gilt market now the real opposition? How high do gilt yields have to go before we're calling the IMF, like 1976?

Answered by: Ian Smith
Answer: No investors that I speak to think there is a realistic scenario where the UK has to call in the IMF. We have a fiscal adjustment in the UK that compares well with peers, gilts supply actual fell this year. The question is more over whether the government can stick to its planned fiscal consolidation or is blown off course by rising inflation and global yields. And even then there are ways through. The more regular argument I hear from gilt investors, besides a desire for spending cuts, is that income taxes need to rise. In that sense the gilt market has been the opposition for a few years. We did this Big Read on the topic earlier this year. There is broad political acceptance of the debt problem but the dynamics have made centrist politicians unpopular and we are seeing the rise of populist challengers. https://www.ft.com/content/681c033e-de48-4edc-9214-339fde583c9a?syn-25a6b1a6=1

Question asked by: AdamBond
Question: What caliber are we talking, when thinking about future interventions into the bond market by Bessent. And what effect would those have on inflation us debt policy.

Answered by: Robin Wigglesworth
Answer: Aside from actual fiscal discipline — I know, right? — I think almost every measure and intervention Bessent might try will either be ineffective or counterproductive. But we could see more subtle policies that fall under the broad category of "financial repression". Not necessarily the sharper, more draconian measures (like dictating investment policies) but softer ones, like tweaking the regulatory treatment of Treasuries. We've already seen some deregulation of banks that should have the effect of encouraging them to hold more Treasuries, and its entirely possible that we see more regulatory inducements for pension plans, insurers, ordinary investors etc to buy more Treasuries if the administration sees the need for this.

Question asked by: Lauressa
Question: Why have emerging markets withstood the sell-off in global bonds?

Answered by: Ian Smith
Answer: Would say a mixture of prior action on fiscal (direction of travel much worse for previously risk-free developed markets like France, US), being proactive to increase interest rates in the post-Covid inflation surge, and a wall of money moving into the asset class as investors bet on a tailwind from a weaker dollar coming into this year. Read more from colleagues here:https://www.ft.com/content/0f69e39e-b41f-4cfe-9c25-f0e1e05a1198?syn-25a6b1a6=1

Question asked by: Jne
Question: Is there also historical precedents where risky assets performed so well despite rising treasury yields?

Answered by: Robin Wigglesworth
Answer: Late 1990s. The 10-year Treasury yield climbed from a low of 4.2 per cent in 1998 to a high of over 6 per cent in 2000, when the Nasdaq keeled over.

Question asked by: Anonymous
Question: At what 10 year gilt yield would you be tempted to buy. Or would you be more tempted by 10 year treasuries, unhedged?

Answered by: Ian Smith
Answer: Not in a position to provide financial advice, sorry, but I'm sure there are wealth managers who would be happy to answer this for you! Uncertain bet right now...

Question asked by: Milton23
Question: Is anyone talking about the liquidity squeeze in the T Bills market as the US shortens duration? With the Overnight Facility drained will future duration shortening not cause a credit crunch in the US?

Answered by: Ian Smith
Answer: This is being closely watched as the US leans heavily on T-Bills (govt debt maturing in one year or less) issuance for its borrowing (https://www.ft.com/content/3fcee89f-b69d-4f4b-a944-39fe1c214fb8?syn-25a6b1a6=1) introducing greater refinancing risk. The US has already gone further than others in shortening the average maturity of its debt issuance and the short-end of the market becomes increasingly important.

Question asked by: Anonymous
Question: Do you think that the rise in JPY yields will see demand for UST from Japan fall over time and that can trigger a increase in US rates and then form a cycle

Answered by: Robin Wigglesworth
Answer: Yes, I think this is a danger, and this is one of the reasons why Scott Bessent intervened in the yen and wants Japan to use a Federal Reserve facility called FIMA to repo its Treasuries (using them as collateral for cash loans) rather than sell them out right.But I see a far smaller danger of this becoming a feedback cycle. At some point Treasuries become attractive versus Japanese government bonds, even after currency hedging costs.

Question asked by: Underdog
Question: Why do you think the US stock markets continue to achieve new heights, despite the rising bond yields?

Answered by: Ian Smith
Answer: Had a few on this: I think the answer boils down to crazy earnings growth driven by the AI boom, which has meant that even though prices have hit new highs, price/earnings valuations (core way of measuring stocks' expensiveness) are undemanding. And other valuation metrics like the Fed model of bond yields vs earnings yields are compelling but do not exert gravity in themselves on valuations. People need a reason to switch out of stocks into bonds, and there are signs US stocks are becoming a more trusted harbour of capital than some previously "safe" sovereign debt markets.

Question asked by: OnTheToilet
Question: Do you think political gridlock after the midterms in the US holding up spending packages, debt ceiling raises, etc could add to investor's worries about the fiscal irresponsibility of the federal government and drive up bond yields?

Answered by: Robin Wigglesworth
Answer: US gridlock does seem like a fairly safe prediction whatever happens, so I'll make it. I don't think debt ceiling standoffs are credible any longer, after so many of them that have been resolved by both parties. I'm sure there will some scary headlines at some point, but investors have learned to look through these. It will be interesting to see if fiscal policy becomes a US election issue. Mortgage affordability does seem to have become a topic in the midterms, but only a small one. I was delighted to read an NBER paper earlier this year that showed how most Americans expect a US debt crisis, but no one was changing their voting in response to the prospect. https://www.ft.com/content/e04f286c-f5ed-46d1-8e3f-0bbe4cce4d3e

Question asked by: Anonymous
Question: Looking at history the sell off seems reasonable and expected, in a way. With inflation high and debt at record high levels, isn’t this just the exuberance of the past 18 years catching up with us?

Answered by: Ian Smith
Answer: Possibly, though there is a danger in just zooming out and saying it is a normalisation. That suggests something that reaches a stable equilibrium, whereas it feels like it needs something significant to pull back on the factors driving yields higher.

Question asked by: Agent Provocateur
Question: How do you explain the remarkable resilience of credit spreads in light of the sell off in government bond markets, rise in rates by central banks, massive borrowing by tech sector and the volatility in equity markets. Is it sustainable and what could trigger a correction in credit.

Answered by: Ian Smith
Answer: Essentially, the global (and particularly US ) economy has remained remarkably resilient (https://www.ft.com/content/bcf0715b-4292-428e-80ec-e6702d430aa4?syn-25a6b1a6=1) through tariffs, war, and the various challenges thrown at it. People have been scratching their heads at razor-thin credit spreads for a while now, though we have seen some widening in European credit in recent days, and in lower-rated credit. What could trigger a correction? The knock-on from rising benchmark borrowing rates for households and the corporate sector, perhaps, or evidence that the AI boom to activity is weakening. Or, related, worse selling in government bonds that prompt some cash-raising in credit.

Question asked by: JohnC
Question: following the Ray Dalio idea that we are seeing another long-term cycle, with governments politically incapable of reducing deficits, which Western government will default first?

Answered by: Robin Wigglesworth
Answer: I don't think any western government will default. I just think we have too much of a EM-centric view of how debt crises play out. They will play out very differently in developed countries that are monetarily sovereign. But it's possible that we are in the foothills of a chronic debt crisis, that plays out over 10-20 years —and manifests itself in debt servicing costs gobbling up more and more of a government's resources at the expense of defence, healthcare, education, infrastructure etc etc — rather than the kind of acute debt crises we've seen in the past (which are characterised by "sudden stops", bond yields spiking, currencies collapsing, and sudden enforced austerity and economic calamity).

Question asked by: FrancescaTed
Question: As you can see, the bond crisis in the UK is of great concern to us Italians

Answered by: Ian Smith
Answer: Italians can be allowed a smile, with France being declared by some the "new Italy" due to its higher borrowing costs and succession of prime ministers struggling to fix its debt problems. But Italy is also a good example of how market fears, such as with Meloni's rise to power, can be overdone, and its spread with Germany has tightened dramatically since then. But Italian debt has sold off in sympathy with France and the UK during this Iran war and its high debt load mean that this surge in borrowing costs -- emanating from Japan, UK, France and the US rather than from domestic concerns -- could still bite.

Question asked by: Anonymous
Question: Apart from what is driving the sell-off I'm interested to know who is driving the sell-off as well.

Answered by: Robin Wigglesworth
Answer: Le sell-off, c'est nous.

Question asked by: Bobino
Question: Given we have 838 days before the current US President's term ends and there is no end to increasing inflation and the Iran war then yields have just got to keep going up. When do you think there will be a significant market sell off? Will it be when 10-year yields hit 6%, 7% or higher?

Answered by: Ian Smith
Answer: Six per cent on the 10-year US Treasury yield is a new danger level that people are talking about, but then we rose through 5 per cent without things blowing up. We're at 5.32 per cent now. These are not magic numbers, though, and it is more about the speed of the yield rise (sharp rises in borrowing costs break things in the financial sector as the UK discovered in 2022). Things like equity-bond valuation models would suggest bonds are a must-buy at these yield levels, but investors are nervous to stand in front of this bond sell-off, understandably. I think we would need something like better evidence that rising borrowing costs are threatening US economic growth for the stock market to care.

Question asked by: Anonymous
Question: Who is buying bonds right now and why are they buying bonds?

Answered by: Robin Wigglesworth
Answer: I never ever give investment advice, but at least bonds do look less unattractive now than they used to. You can now lend money to the UK or US government over the next two years and make almost 5 per cent a year guaranteed. And if the global economy does weaken or AI implode, then those longer-dated bonds could rally hard. I think its important to remember that there are no bad assets only bad prices, and bond prices look a little less bad right now (though they can get cheaper of course...)

Question asked by: Ottimo Massimo
Question: Are there any useful comparisons from history that are useful in understanding today's bond market dynamics?

Answered by: Robin Wigglesworth
Answer: Finally an opportunity to plug my book! There are no perfect parallels, but I do think there are fascinating parallels between the railway bond bubble of the early 1870s and today's AI mania.Railways truly were a revolutionary technology that reshaped the entire world, but the boom was still pocketed by several crises and one humongous one, in 1873, which led to what is still the longest recession in US history. The lesson is that a technology can truly be transformational but still lead to some financial carnage.That said, there are important distinctions. The 19th century railway bonds were more like venture capital in fixed income drag, while the AI debt sold today is mostly issued by extremely profitable large companies with strong balance sheets (though those balance sheets are weakening at the moment).

Question asked by: Man about Town
Question: Will France need a bailout? Wiil Germany play ball? Will the French people accept the terms imposed on them by the bailout? Is the euro dead?

Answered by: Ian Smith
Answer: IF things in France get significantly worse, there is a genuine question about whether France can be allowed to have a debt crisis, as the second biggest economy in the euro area. We looked at this Q in this week's Big Read, so I won't rehash here:https://www.ft.com/content/9b252b46-a87c-45e7-a09a-45a39ce077b8?syn-25a6b1a6=1Most investors think that ultimately the European Central Bank will do what it takes to protect the euro and the Eurozone. And that we are a way short of the kind of market levels that would justify action. And the action would probably start with something verbal, so there are stages to this. You would have to expect some kind of shift in direction on government policy too if it came to that.It has got genuinely a little worrying in recent sessions as other Eurozone debt, credit and the euro has got caught up in the selling. That shows you some people are nervous about contagion

Question asked by: Big Dog Basil
Question: This is all pretty technical so far. For those of us less attuned, would I be right in thinking this is a great opportunity to buy a retirement gilt ladder yielding around 5% pa and hold till maturity (2029-37)?

Answered by: Robin Wigglesworth
Answer: Nothing we write should ever be construed as investment advice. I certainly never ever give any, having seen how many people far smarter than me get ritually embarrassed by the market all the time.

Question asked by: Anonymous
Question: why are tech stocks not moved at all by higher yields as the assets with longest duration?

Answered by: Robin Wigglesworth
Answer: I'm also a little surprised that there's so far been so little response. I think that incredibly strong earnings growth and optimism over AI may simply be overpowering the normal valuation impact of higher yields on long-duration assets.It could be a related to what our old colleague John Authers often termed the Wile E Coyote factor — that the market simply powers ahead even as the ground beneath it has disappeared, and eventually gravity wins over. But as long as earnings are strong and the economy remains resilient then I think it is easy to ignore the impact of bond yields.

Question asked by: H. Waverly
Question: What could be the end game for governments' debt problem? How do countries differ? Reducing the deficits looks unlikely for political reasons in most countries. Could be yield curve control part of the solution instead? If so, wouldn't that be the end of the fiat monetary system as we know it?

Answered by: Ian Smith
Answer: This is the big question. We talked a little bit about this in a recent Big Read on the word's $2tn (and climbing) debt interest bill. https://www.ft.com/content/4f28ef6c-f727-4d36-88a3-bbdbd13ddfbf?syn-25a6b1a6=1 History suggests that governments ultimately respond to surging borrowing costs by reining in fiscal policy and there are good examples of where this has happened such as Canada in the 1990s. So it might be that the refinancing bill reaches a level that it is squeezing government spending so much that politicians act.The good route out is growth, which can take the heat out of the debt/GDP overhang. But that is lacking in many countries. Less good options including letting inflation run hot to inflate away debts, or financial repression to intervene to bring down long-term borrowing costs through eg yield curve control. Some think that is where we are heading.How do countries differ? check out things like the IMF. But mindful that stats aren't everything: the US has horrible debt dynamics but also has a lot of structural demand for its debt as the world's pre-eminent liquid asset.https://www.imf.org/external/datamapper/GGXWDG_NGDP@WEO/OEMDC/ADVEC/WEOWORLD

Question asked by: Basel area
Question: How worried should we be about the JPY funding unwind by hedge funds ? Is that the main worry ?

Answered by: Robin Wigglesworth
Answer: That could cause ructions, temporary ones. I'd worry more about Japanese investors repatriating money now that the Japanese government bond market looks more attractive than it has for generations. Japan is kind of the Saudi Arabia of savings, having accumulated a massive amount of overseas assets over the past three decades. From the top of my head Japanese institutional investors hold north of $2tn of overseas bonds, for example (that is excepting the central bank and ordinary investors, which also hold a lot). I suspect this is one of the factors already fuelling the French government bond selloff, as Japanese investors have tended to buy a lot of that market because of its superior liquidity compared to the German bund market.

Question asked by: Anonymous
Question: Question is whether sell off is driven by algorithms responding to changed assumptions about the future path of central bank tightening and increasing volatility in the bond market.. Nearly all large bond investors rely on models and algorithms to guide or implement their fixed income trading.

Answered by: Ian Smith
Answer: I am not sure algos are a driving factor: the sell-off has been sparked by a significant repricing of inflation and the interest rate path, as well as fears that surging borrowing costs could tip some indebted economies into a worse debt crunch. US Treasury yields have also pushed higher due to a domestic economy that continues to defy the doubters. Though, computer-driven trading firms have ridden the rising-yields trend to great success, so maybe that has provided a tailwind. (https://www.ft.com/content/75b0ab84-a252-4ea1-9058-c9ee7ca07f4f?syn-25a6b1a6=1). But I think the exacerbating factor in the big intraday yield jumps is more likely the hedge fund squeeze that we've seen, similar to past episodes of volatility such as following Donald Trump's 'Liberation Day' trade tariffs. For example, this month in Europe has seen big volatility in swap-spreads – the relationship between government bonds and related interest rate derivatives – that are a clear signal of trades blowing up that have then helped drive French and Italian yields wider against swaps and Bunds.

Question asked by: Faruk
Question: Are we underestimating the role of private-sector capital demand in this bond sell-off? With governments running large deficits and hyperscalers tapping bond markets for AI capex, could term premia stay elevated even after inflation falls and central banks cut?

Answered by: Ian Smith
Answer: I don’t think we’re underestimating it, no. There is a genuine worry about a supply-demand mismatch in long-term government debt markets. Most central banks have stopped buying in recent years and have been reducing their holdings, and some pension funds have pulled back as retirement systems change. At the same time, combined government and corporate debt supply continues to set records. There is much debate about whether the flood of AI-related debt issuance is making things worse, we do hear from market participants that some of the credit purchases are funded out of gilts etc, but that is anecdotal. Still, it introduces a big and relatively price-insensitive new debt issuer just as long-dated bond yields indicate the market is awash with supply.

Question asked by: Jos Gallacher
Question: Would the gilt market react if the BoE changed its policy on paying interest on reserves?

Answered by: Ian Smith
Answer: Probably, though it would depend on the detail. The Bank of England has said that cancelling interest on commercial bank reserves could impact financial stability – if it deters commercial banks from holding this ultra-liquid asset – as well as the transmission of monetary policy, if banks tried to recoup the losses they suffered through higher lending rates or lower deposit rates. For the market, from conversations with investors, the view is that if banks switch from reserves into gilts that could boost demand for UK short-dated debt, bringing down yields there. But it could complicate a future attempt at QE if banks are reluctant to sell gilts to the BoE in exchange for reserves.

Question asked by: Nangle
Question: Do you believe in r-star, and if so where would you estimate it for the US?

Answered by: Robin Wigglesworth
Answer: For people who might not be familiar with the joys of the eminently punnable concept of R*, it is supposed to signify the long-term level of "neutral" interest rates that neither stimulate or restrict economic activity. I believe it is a useful but comically overthought concept, both by people love and hate it. But if i had to pin it somewhere, then I think the 10y10y forward — the markets-implied yield of the 10-year Treasury yield in a decade's time — is a decent proxy. Last time I checked it was slightly north of 6%, which seems reasonable to me (and then you have to adjust for a reasonable time premium to guess what kind of Fed interest rate that implies).Now, back to the Alphaville mines you go Toby.

Question asked by: Ekonomism
Question: Caballeros 2017 article explains why the glut of safe assets now drives up interest rates. But it does not explain why the AI boom would occur at the same time. Are these phenomena related, or is it pure coincidence that they are both occuring at the same time?

Answered by: Ian Smith
Answer: Interesting one. Personally I can’t see that the origin of the AI boom had too much to do with capital markets dynamics (sadly not everything is due to markets). Hyperscalers funded themselves out of their sizeable cash flows before they turned to investors. But it has obviously become a big part of their financing since. Sky-high equity valuations have supported equity issuance. But debt investors are a different beast. Rising credit spreads on newly issued debt and higher CDS spreads suggest investors’ willingness to put up the capital needed to sustain the boom is not limitless.

Question asked by: Merrion
Question: How does the new and very different use case for government debt - backing "stable" coins - affect the market?

Answered by: Ian Smith
Answer: The US government presents a rising stablecoin industry as one of the growing areas of demand for T-Bills, sovereign debt maturing in a year or less. And arguably the Treasury needs fresh sources of demand, given the US is expected to issue as much as $1tn in net T-Bills over the next year, with this ultra-short term debt climbing close to a quarter of the entire US debt pile in the coming years, on some Wall Street estimates. If the stablecoin industry does not grow as expected, that could be a problem. If it does, expect more scrutiny on the risks, too: the Bank for International Settlements has previously warned of the potential for a run on a stablecoin to trigger a “fire-sale risk” for T-Bills, creating volatility in a market that is core to the transmission of US monetary policy.

Question asked by: Aeschylus
Question: The rise in yields feels unanchored. What can stop it: Only a credible US fiscal consolidation plan? A sharp adjustment down in equities? Or a normal, organic, convergence to a new normal high?

Answered by: Ian Smith
Answer: It has felt fairly relentless. So many factors are pushing for higher yields: another burst of inflation from the Iran war; US economic resilience; worries that fiscal policy in some big indebted economies such as France is becoming unsustainable, creating the risk of yet more debt supply. I would be reluctant to declare a new normal, things could change quickly. As for catalysts for a reversal, most obvious would be something that undercuts the market’s expectations for further interest rate rises, such as a lasting US-Iran truce that can turn oil prices lower. Dire economic data out of the US or Eurozone could also make further rate rises difficult, dragging short-term yields lower. I think that would pull the longer-term yields down too, but we’d have to see. Yields there are more sensitive to supply, and yes a significant US fiscal consolidation (seems remote right now) could help. Real trouble on equity markets could change the perception of fixed income again, but I suspect that would need a crapout in corporate earnings rather than simply the pressure from higher yields.

Question asked by: Anonymous
Question: What are the risks for retail investors in holding linkers-superficially attractive at 2.5% above a probable persistently high inflation rate

Answered by: Robin Wigglesworth
Answer: Inflation proofed bonds are typically very long duration assets — so they are very sensitive to changes in interest rates. So if inflation stays high and rates keep going up then they still will be hurt, and probably severely. Our colleague Tony has written a fantastic explainer of this issue, which you can read here: https://www.ft.com/content/f9cf6d1a-0313-4c1f-aeb2-df1f64bd5d3e

Question asked by: Anonymous
Question: To what extent do you think the current bond selloff is a mechanical phenomenon due to passive investment strategies compared to fundamentals of inflation expectations and unsustainable deficits?

Answered by: Robin Wigglesworth
Answer: I think some technical factors have come into play, such as some hedge funds getting wrongfooted in Europe and having to deleverage, and the convexity issue with mortgage-backed securities in the US — as our colleague Toby wrote about yesterday: https://www.ft.com/content/a04ef3b4-2fcf-48f9-ab34-2c40c39d9a0c But i dont think passive funds have had any impact whatsoever. If anything they will have acted as a dampening force, given that there have been strong inflows into passive bond funds all year ($448bn YTD as of last week, compared to $278bn for active bond funds). $TLT, a long Treasury ETF, has alone taken in $3bn over the past month, and nearly $10bn over the past three months.

Question asked by: Alvin Cuthand
Question: Should the US 10 year yield remain out of control for an extended period I imagine new standards for valuing other debts will be found. Any thoughts on what they could be?

Answered by: Robin Wigglesworth
Answer: I don’t think anything can or will replace Treasuries as a global benchmark in our lifetime. In terms of alternatives, what is even close in terms of size, influence and liquidity? We may not like it, but its the least smelly shirt in the closet, to use that well-worn cliché. But in terms of “true” risk free rates there are many viable contenders (albeit mostly short-term overnight rates collateralised by Treasuries).

Question asked by: Anonymous
Question: That's all we have time for. Thanks FT readers for your questions and Robin and Ian for your interesting responses. We'll be back with another Ask an Expert soon. Visit www.ft.com/ask-an-expert.

Answered by: Robin Wigglesworth
Answer: Cheers everyone! This was fun. If you have more questions then feel free to follow Ian and his team, as they've been doing god's work in covering all this stuff.

Answered by: Ian Smith
Answer: Thanks Lucy, Robin and everyone for your questions. One of the most important debates in the world right now (but I would say that). See you next time