High Anxiety in the Bond Market A return to pre-2008 interest rates isn’t cause for financial panic.
The WSJ Editorial Board:
Apparently “rout” is the new word for interest rates returning to a historical norm. That’s one impression from the freakout now attending a repricing in global bond markets that’s resetting the global financial system to its pre-2008 level.
Note the dates here. The 30-year U.S. Treasury yield on Tuesday touched 5.339%, its highest since 2007. The 10-year at about 4.7% is near its highest level since early 2025. The benchmark French 10-year, at about 4.1%, is its highest since 2008. The 10-year German bund, at about 3.26%, has returned to its level of 2011. None of these moves upward have been sudden, despite the hubbub in market commentary this week.
In other words, yields finally are reverting to normal after the low-rate era following the 2008 financial panic and European sovereign crisis. The outlier is Japan, and it’s telling. There the 10-year government bond, at about 2.93%, is now at its highest yield since 1996. But Japan embarked much earlier on the extreme monetary and fiscal policies that became common elsewhere after 2008. This too is a story of unwinding abnormal conditions.
The upward rate trend might signal faster economic growth ahead. Tech companies have an insatiable appetite for capital, especially to fund artificial-intelligence investments. Such borrowing stands at $200 billion so far this year, according to Nomura Securities, which is about 25% of the U.S. Treasury’s net debt issuance in that period. Companies are willing to pay higher rates for capital in line with their hoped-for returns. Investors in turn are recalibrating the yields they’ll demand to hold stodgy government debt.
While it sounds frightening to say rates are higher than they’ve been in nearly 20 years, the past two decades are the era that was abnormal. The U.S. economy has survived—thrived, actually—during periods of higher interest rates. The return of normality augurs well for the productive allocation of capital, which is good for growth and job creation.
This isn’t to ignore the two more worrying reasons for higher yields. Concerns about future inflation may explain some of the rise, and the fiscal mess of most Western governments should push up yields.
In the U.S., federal debt held by the public has ballooned to 100% of GDP from 32% in 2008. Rising rates create new budgetary stresses. Net interest on the debt is on track to cost the Treasury more than $1 trillion this fiscal year, the second- or third-largest line item in the federal budget behind Social Security and, possibly, Medicare. Those risks aren’t new, however, and were at least partly baked into yields before the surge of recent days.
Other financial risks have built up during the era of low rates. Britain’s gilt crisis in September 2022 and the Silicon Valley Bank collapse in March 2023 were warnings that some investors or institutions might experience distress during the transition back to normal yields. Borrowers of all stripes will have to adjust—not least the Western governments that have spent and borrowed as if near-zero interest rates would last forever.
If interest rates are “normalizing”, are P/E ratios also “normalizing” back into their historical Equity Risk Premium range?
But what is “normal”?
Real yields (per the Cleveland Fed based on inflation expectations) are only back to 2.0% while actual core PCE inflation above 3.0% is well above its 1994-2021 levels. Inflation expectations better be right!
Import prices (ex-fuel) keep rising, +4.5% YoY in July but +6.5% a.r. YtD …
… dragging goods prices higher.
On a YoY basis:
- Industrial supplies & materials: +15.7%
- Capital goods: +6.6%
- Manufacturing: +4.7%
- Nonmanufacturing: +19.1%
- From Canada: +15.0% (+12.0% a.r. last 3 months)
- China: +2.7% (+7.3% a.r. last 3 months)
- Asian NICs: +8.3% (+9.7% a.r. last 3 months)
(…) For now, the market is underpinned by fund managers’ optimism on the economy. Most now believe there will be “no landing” and no slowdown in growth — great for stocks but bad for bonds as it implies rates will need to rise:
Further, executives’ optimism on earnings calls has brought the percentage of fund managers expecting double-digit earnings growth over the next year to its highest since 2021. This is a powerful brew for equities: (…)
Morningstar found that total net inflows into long-term US funds (both stocks and bonds) topped $100 billion for the fourth month in a row in July. That’s unprecedented. When professional and retail money are this positive, the stock market will go up, come what may.
Fund managers seem optimistic in large part because they’re confident that the oil price won’t veer out of control. On average, they think crude will be $76 per barrel at year’s end. (…)
One point of concern is that the asset allocators were markedly more optimistic than those who invest directly in the oil markets. January 2027 Brent futures have risen back above $85, a high for the war period barring a few weeks in May:
Confusion hangs over the US strategy on Iran, if indeed there is one. But big money managers appear a tad more complacent about the risks than those closest to them — which in turn suggests more downside than upside for stocks.
BofA found no consensus on how markets might react to a Democratic midterm sweep (taking control of both the House and the Senate). Fund managers don’t think it will happen. Only 23% expected a sweep — slightly reduced from July after some fractious Democratic primaries:
Comparing this to the odds produced by the political nerds trading on prediction markets, it does look as though fund managers haven’t caught up with events. Both Kalshi and Polymarket make a Democratic sweep a 50-50 shot:
As the summer at last winds down and the election campaign comes into focus after Labor Day, there’s plainly a risk that investors will catch up to the threat of a very fractious two years of politics ahead.
Look Ma, no cash!
Meanwhile:
(Rosenberg Research)
US Revival?
Why not?
@realDonaldTrump
Why?
One of the key areas the Defense Department is assessing is whether to pull back troops from the Persian Gulf, where America’s large overseas military bases have been battered by months of Iranian strikes, two people familiar with the ongoing analysis said.
The damage to these facilities has prompted a once-in-a-generation chance for the Pentagon to reconsider its presence in the region. The Defense Department has already signaled that it might not rebuild its bases as they were before the conflict. (…)
America’s largest and most permanent bases in the Middle East are in the Persian Gulf, where Bahrain hosts the headquarters of the U.S. Fifth Fleet and where other states, such as Kuwait, house Army and Air Force assets. (…)