Global Bond Selloff Extends as Rate Hike Expectations Grow

Key Takeaways

• Global bond yields spiked to multi-decade highs as a bond selloff deepened.
• Investors have grown increasingly concerned over rising inflation risks amid the latest Middle East flare-up.
• Markets shifted their expectations toward further interest rate hikes this year.

A global bond selloff worsened on Tuesday, with government borrowing costs approaching multi-decade highs in the United Kingdom and Japan as renewed Middle East hostilities exacerbated inflation fears. US 10-year Treasury yields rose 0.03 percentage points to 4.78%, their highest level since January 2025. Japan’s benchmark 10-year bond yield hit 3%, its most elevated since 1996.

The bond selloff rippled across Europe, with yields briefly spiking across other major economies following the release of eurozone inflation data. Rising energy prices drove eurozone consumer prices up by 3.3% year over year in August after they rose 2.9% in July, according to Eurostat’s flash estimate. UK government bond yields also rose sharply, with the 10-year gilt passing 5.2%, its highest level since the peak of the 2008 global financial crisis. Longer-term 30-year government bonds hit their highest level since 1998 at 5.89%.

The spike in borrowing costs comes as the latest flare-up in the US-Iran war has raised concerns that central banks will hike interest rates to combat inflation from higher energy costs. Brent crude oil futures rose 3% on Tuesday to trade at $88 per barrel.

“Government bond yields have risen substantially this year around the globe. While multiple factors have contributed, in my view, prolonged above-target inflation has been the biggest reason for the sovereign bond selloff,” says Dominic Pappalardo, chief multi-asset strategist at Morningstar Wealth.

US Bond Yields Rise as Fed Rate Hike Expectations Grow

In the US bond market, the yield on the 30-year Treasury bond rose to 5.24%, not far below its post-financial crisis high of 5.31%, set in mid-August. Higher US bond yields come amid expectations that the Fed will raise interest rates to battle above-target inflation. That was fueled by comments from new US Federal Reserve chair Kevin Warsh’s debut speech last week at an economic symposium in Jackson Hole, Wyoming, in which he indicated his commitment to fighting inflation. Investors now forecast a two-thirds chance of a rate hike later this month, according to the CME FedWatch Tool, up from less than 40% a week ago.

“Warsh’s hawkish tone on core PCE and rate primacy, reinforced by resilient data and the US Treasury’s growing role at the long end of the curve, raises the odds of further tightening ahead,” says UBP group CIO and asset management co-CEO Michaël Lok.

Government debt yields have been marching higher for much of this year, as investors have also grown wary over ballooning government debt and increased corporate debt issuance to fund the massive artificial intelligence infrastructure buildout.

Compounding inflation concerns “is the massive supply of corporate debt to fund AI capital investment,” Pappalardo says. He notes that much of that issuance is concentrated among longer-term securities. “This debt offers another option for investors and will pay them a higher yield than government bonds. As investors absorb this AI debt, demand for government bonds can wane, which drives yields ever higher.”

European Bond Yields Spike

In Europe, the bond selloff was accelerated by Tuesday’s hotter-than-expected inflation reading. The European Central Bank is now predicted to raise its key interest rate by 0.25 percentage points next week. “With inflation still accelerating, the ECB is all but certain to hike at next week’s meeting, in line with our expectations,” says Oxford Economics senior economist Leo Barincou.

German government bonds sold off on Tuesday, with the benchmark 10-year Bund yield reaching 3.36% around midday before easing slightly in afternoon trading. The rise was particularly pronounced in two- to five-year maturities, where yields reached their highest levels since 2008, while 30-year Bund yields were little changed. Shorter-dated yields are especially sensitive to monetary policy expectations, with rising energy prices fueling inflation fears and expectations of further interest rate increases.

The yield on the 10-year Italian BTP hit its highest level since November 2023, reaching 4.17% during Tuesday’s trading session. The yield on the 10-year BTP peaked at 4.22% following the release of inflation data for Italy and the eurozone, before retreating to early session levels in the afternoon. The rise in the yield on the 30-year BTP was less pronounced, reaching 4.94%.

In the UK, the latest bond selloff adds pressure on Prime Minister Andy Burnham ahead of his government’s first Budget on Oct. 28. Futures markets have fully priced in a 0.25-percentage-point hike in UK interest rates by the end of the year to combat rising inflation, with the Bank of England’s Nov. 5 meeting seen as the most likely time for it to happen.

In Japan, Prime Minister Sanae Takaichi’s spending plans, including a consumption tax cut, have sparked concerns about the sustainability of its fiscal position, fueling higher bond yields and bets against the yen. Markets are now pricing in the likelihood of a 0.25-percentage-point rate hike at the Bank of Japan’s next meeting on Sept. 18.

Looking ahead, Morningstar’s Pappalardo sees the upward pressure on bond yields continuing. “The main themes pushing rates higher are likely to persist for the foreseeable future,” he says. “Sure, there is a chance some more permanent resolution is reached in the Middle East soon and the Strait reopens. But even once that occurs, it will take several months for oil transports to reach pre-war levels, so inflation will take a while to normalize. Elevated bond issuance related to government spending and corporate borrowing seems to be in place for the foreseeable future, keeping competition for investor capital high.”