Global equity markets continue to grind higher on the back of the trade war de-escalation. Moreover, a U.S. federal court recently ruled that President Trump had overstepped his authority in using an emergency law to impose tariffs, leaving investors and businesses questioning the implications. The U.S. administration has indicated it will appeal the court’s ruling and it appears too early to draw any real conclusions. U.S. stocks are close to where they began the year, whereas other stock markets are nearing or sitting at all-time highs. As trade tensions ease somewhat, markets have increased their attention to movements in government bond yields

Long-term yields moving higher in many places

During periods marked by elevated uncertainty and investor concern, government bonds typically see their prices rise as investors seek the stability and safety that can be offered by government bonds. But that relationship has been put to the test this year. For example, at the beginning of April when the U.S. government unveiled its reciprocal tariffs on a range of countries, longer-term U.S. government bond yields rose abruptly (and U.S. government bond prices fell). And after a brief recovery, long-term U.S. government bond yields continued to climb higher, suggesting investors may be reassessing some of their views around the U.S. and its government.

It is tempting to think this is a U.S. issue, but it appears to be part of a global phenomenon. Despite the moves noted above, the U.S. 10-year Treasury yield has fallen modestly year-to-date, compared to sovereign yields in other major developed countries that have risen. Meanwhile, the rise in the 30-year U.S Treasury yield has been much more notable. In fact, longer-term government bond yields across a range of developed countries sit near or above levels that haven’t been seen in well over a decade. This suggests that investors are demanding more return than they have in the past for locking up their money in longer-dated loans to governments.

Investors increasingly focusing on the sustainability of government finances

There may be a variety of factors that are responsible for the recent move higher in longer-term bond yields. However, concerns over the trajectory of government finances appear to be playing some part. Debt levels across regions have been trending higher in recent decades. That had not been a big concern when interest rates were falling and were relatively low, but the interest rate regime changed a few years ago and the cost of servicing debt has increased as a result. In addition, budget deficits are aggravating the issue as some governments continue to plan to spend more than they are earning, which will require them to raise even more debt in the future. The most recent example is in the U.S., where the government is trying to pass a bill that includes higher spending and lower taxes and will require another increase in the government’s so-called debt limit. Other regions are dealing with similar issues to varying degrees.

The unsustainable nature of governments’ fiscal trajectories is not new. It has been a concern on the minds of some investors for as long as we can remember. Yet that has not presented too much of a hurdle for governments and investors. Nevertheless, at some point, investors may demand a return that is high enough that governments may be forced to take more decisive action to address their fiscal issues. We are not sure that time is near but remain mindful of the risk.

Thanks for tuning in and see you in two weeks.