Long-dated bond yields rising

At Tricio we look at charts in order to gauge investor sentiment and behaviour. Over the summer we have noted rising bond yield risk, especially longer-dated bonds. The fundamentals behind this include high budget deficits, rising debt ratios, fears for Fed independence, slow growth and weak governments in Europe and worries that inflation targets will, over time, be missed.

In our currency podcasts we have talked about higher bond yield risk in Japan, with John Calverley, our Chief Economist, laying out the groundwork for 3% risk in the 10-yr. JGB. The 30-yr. JGB yield (chart below) is already here! The risk is that the new all-time high yields will extend towards 4% in the 30-yr. JGB in this cycle.

The US 30-yr. bond (chart below) is one of the more liquid long-dated markets since it was reintroduced in 2006. Attempts to clear the 5% area on a sustained basis in 2023 and this year have drawn out buyers. So far, so capped. The risk of course is that this barrier gives way on a sustained basis, leaving 6%/6.30% at risk and potentially a lot higher if seen.

French political risk sent long-dated bond yields higher last week (chart below) and pressure above 4.4% is being seen. This is bringing the 2011 bond yield highs near 4.5% into focus. A sustained turn above this area would see 5% pressed again, last seen right before the global financial crisis.

German 30-yr. bond yields (chart below) are being dragged higher by other markets to some extent, and by the prospect of increased infrastructure and defence spending. The recent push above the 3.25% area 2023 yield high will be putting the 4% zone into focus, last seen in 2011.

Finally, in the UK the 30-yr. gilt yield (chart below) is pushing well away from 5% (5.60% being pressed now). The flat blue line on the chart below shows that the UK is in a similar situation to Japan – highest bond yields in over 25 years! The market (fuelled by tabloid headlines) seems to think that every rising basis point here is another nail in the coffin for government budget plans. Much may become clearer in the coming months at the Autumn budget of course.

Time to flee or time to buy? Bond markets can be tricky – they will look offered as you like and then turn on a dime. Investors in many other asset classes, it could be said, base a lot of their return/risk valuations and decisions on bond yields. If you take them as a risk-free rate of return, can UK investors beat a 5.6% yield every year for 30-years, with a potential capital gains kicker if bond yields fall back to 5% or lower?

So it all depends on your guess for inflation and debt issuance prospects. In the UK – and other European and US markets, uncertainty rules. But, long-term investors who still believe that fiscal prudence has not been thrown out of the window forever may be looking at current long-dated bond yields and start to add some to the portfolios.

The UK needs a turn in sentiment, German bond yields may find 3.5% tough to reach and a turn below 3%, if seen, could suggest that a range top is being set. French political risk may last beyond the confidence vote next week. But, at some point there should be clarity and a turn back to 4% and lower is not out of the question. In the US? See if the 5% area range top can hold despite all of the turmoil with the Fed. Watch US jobs this Friday for near-term clues of course!

Japan is still the one long-dated bond that we think has long-term potential to see the rise in yields extend. While we may not be looking for 5% yields here, the direction of travel is expected to be in that direction. Which is one of the reasons that we still look for USD/JPY Y140 to give way and talk about Y120 and even Y110 in our FX podcasts!

Gerry Celaya, Chief Strategist