Charts of the Month

CHART 1 – BONDS & BEARS

We have shown this chart several times before because it highlights one of the most important relationships in financial markets.

Almost every major equity bear market of the past 50 years has been preceded by a significant rise in government bond yields.

The reason being that higher borrowing costs tighten financial conditions, slow economic activity and provide investors with a more attractive alternative to risk assets.

That does not mean every increase in yields is a problem. Markets can generally adapt to gradually higher rates, whereas sharp re-pricings tend to be far more disruptive.

The recent move higher in yields has remained relatively orderly, which is encouraging.

However, with governments, companies and households carrying far more debt than in previous cycles, the global economy is becoming increasingly sensitive to rising funding costs.

Higher yields will eventually expose cracks in economies and markets, but history suggests policymakers are unlikely to sit back and watch.

Meaning a more explicit effort to cap borrowing costs will likely materialise if yields do continue to rise.

CHART 2 – GOOD GROWTH?

As this chart shows, the US 10-year Treasury yield has historically moved closely in line with nominal GDP growth.

At first glance, the recent rise in yields therefore looks justified by a strong economy.

US GDP growth has been running around 6% year-on-year in nominal terms (blue line), supported by large fiscal deficits and the surge in AI-related capital expenditure.

However, the picture becomes less convincing beneath the surface.

Trade activity and household consumption are showing signs of fatigue, whilst several forward-looking economic indicators point to a more subdued growth outlook.

This suggests any further increase in borrowing costs would be driven more by concerns over inflation and excess bond supply, rather than “good” economic growth.

Which matters because higher yields driven by stronger growth generally speak to a healthy investment backdrop.

Higher yields driven by inflation fears and debt issuance tend to be far less welcome.

CHART 3 – PEAK PRICE PRESSURES?

Historically, US Treasury yields have moved closely with inflation expectations.

When investors expect persistently higher inflation, they demand higher yields to compensate for the loss of purchasing power. As a result, inflation expectations and bond yields tend to rise together.

That relationship held during the inflation scare of 2021-22, when price pressures quickly became broad-based and persistent.

This time looks different.

Although inflation concerns have resurfaced (due to disruptions in energy markets), longer-term inflation expectations (blue line) remain relatively well anchored.

Which suggests much of the recent inflation risk has already been reflected in borrowing costs.

If yields continue to rise from here, investors may need to look beyond growth and inflation, towards surging debt issuance, for an explanation.

CHART 4 – BORROWING BINGE

Remarkably, it took the US government more than 200 years to accumulate its first U$10 trillion of debt.

Since then, it has added almost U$30 trillion in little more than two decades.

The total debt stock has risen by over U$3 trillion in the past year alone, taking outstanding Treasury securities to almost U$40 trillion.

That helps explain why the recent rise in bond yields is about more than inflation and growth. Increasingly, it reflects the sheer volume of debt that financial markets are being asked to absorb.

Nor is this just a sovereign story. The same dynamic is emerging in parts of the private sector, with the technology hyper-scalers increasingly tapping debt markets to fund their AI ambitions.

Few policymakers appear willing to bring this borrowing boom to an end, suggesting structural pressure on bond markets is likely to persist.

The question is not whether economies can tolerate materially higher borrowing costs.

It is how long before policymakers prove, once again, that they cannot.