Global equity markets continue to grind higher on the back of the trade war de-escalation. A three-judge panel of the U.S. Federal International Trade Court ruled on May 29, 2025 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 appealed the Court’s ruling. It is too early to draw conclusions regarding the outcome. The S&P 500 Index is near the level at which it began the year. Other stock markets are nearing or sitting at all-time highs. As trade tensions have eased, markets have increased their attention to movements in government bond yields. We discuss this more below.
A brief primer on government bond yields
A government bond is a form of debt issued by sovereign countries to fund spending and cover financial obligations. For major developed nations, these bonds are often considered lower-risk investments, since they are backed by countries with reliable revenues, political stability, and liquid capital markets. The yield on these bonds (the interest payment divided by the market price of the bond) can effectively be considered a proxy for the cost of government financing and the return demanded by investors to lend to that government. The higher the yield, the greater return investors seek to lend to a government, and vice versa.
Bond instruments can vary in maturity with differing factors driving yield changes. The yields on short-term government bonds (ie. five years and less) are generally subject to a mix of market factors and central bank policy (ie. interest rates), whereas long-term yields are driven more by broader market dynamics and fiscal stability. In a "normal" environment, markets tend to pay close attention to interest rate decisions by central banks (influencing short-term yields more) but in recent weeks and months, the focus of investors has been on the rise in longer-term government bond yields.
Long-term yields moving higher
During periods marked by elevated uncertainty and investor concern, government bonds typically see their prices rise (and yields fall) as investors seek the stability and safety that can be offered by government bonds. At the beginning of April, however, 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). Following a brief recovery, long-term U.S. government bond yields continued to climb higher, suggesting that investors may be reassessing the stability of the U.S. and its government.
Recent increases in bond yields appears to be a global phenomenon. The rise in the 30-year U.S. Treasury yield has been broadly in line with yield increases in Canada, Germany, Japan, Australia and the U.K. Long-term yields in a range of developed countries are now near or above levels that have not 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 responsible for the recent move higher in longer-term bond yields. Concerns over the trajectory of government finances appear to be playing some part. Debt levels across regions have been trending higher in recent decades. These debt levels had not been a big concern when interest rates were falling and relatively low, but the interest rate regime changed a few years ago and the cost of servicing government debt has meaningfully increased as a result. In addition, budget deficits are aggravating the issue, as some governments continue to forecast budget deficits and therefore 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 (ie. lower revenue) and will require another increase in the government’s debt ceiling. 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 among investors for decades. At some point, however, investors may demand bond yields that are high enough to force governments to take more decisive action to address their fiscal issues. The pressure appears to be mounting of late. We are watching bond market activity closely.
If you have any questions, please do not hesitate to contact us.
Drew M. Pallett LL.B.
Senior Portfolio Manager and Investment Advisor
RBC Dominion Securities
Email: drew.pallett@rbc.com