Sorry, no search results could be found.
8 Sept 2026 | 3 minutes to read
(All equity data is MSCI; all data in sterling unless stated)
Despite rallying late in the week, sovereign bond markets remain nervy amidst a broad-based sell-off over the past two weeks. Bond yields have moved higher across major developed markets, particularly at the long end of the curve.
The root cause is clear, with a synchronised repricing of inflation and monetary policy expectations the result of the drawn-out confrontation in the Middle East. The Iran war continues to stoke fears of longer and more persistent inflation. And this has coalesced with the milestone of US debt hitting the $40trn mark. The absolute number is perhaps not the key concern, rather it is the widening US fiscal deficit and the growing cost of debt interest which is likely the greater cause of market consternation.
The shift in market pricing has also been reinforced by more hawkish rhetoric from policymakers, as the flexibility for central banks to maintain a more accommodative monetary policy stance abates. Federal Reserve (Fed) chair, Kevin Warsh, has ultimately been non-committal on policy direction, but some investors have concluded that the chances of an interest rate hike later this month have increased. Front-end rates have moved higher as a result.
Yields on longer dated bonds have risen further still, however. Investors are demanding greater compensation for bonds with longer to maturity amidst the heightened geopolitical uncertainty, greater inflation concerns, and the possibility of interest rates remaining higher for longer than previously anticipated.
The backdrop of a relatively benign easing cycle is more challenged. But many developed market sovereign bonds are now pricing in a lot of bad news, offering attractive returns to investors able to accept the potential volatility. The 10-year UK Government Gilt yield is currently close to 5.2%, while the US Treasury equivalent hovers close to 4.8%.
Sharp bond market moves come with significant implications for finance ministers and central bankers alike. With the Autumn Budget now firmly on the horizon, the UK Government’s own independent economic forecaster, the Office for Budget Responsibility (OBR), will bake higher yields into its projections if they persist. With the 10-year gilt yield rising from 4.2% before the Iran war, today every 0.5% increase will cost c.£6bn more in annual debt interest payments by 2029-2030.
Elsewhere, Japan's 10-year bond yield hit 3% for the first time since September 1996 last week. But even amid the Bank of Japan’s (BoJ) gradual monetary tightening cycle, Japanese interest rates and government bond yields remain substantially below their US equivalents. And higher US Treasury yields are sustaining capital flows into dollar-denominated assets. This has supported demand for dollars and weighed on the yen. A weak yen has also been reinforced by Japan's dependence on imported energy. While a modestly weaker yen can support exports, it also increases imported inflation.
As a result, Japanese authorities have recently intervened in foreign-exchange markets to prop-up the yen, with speculation rife that a further intervention was undertaken last week. But this does not address the underlying cause of yen weakness. For that, the BoJ would need to tighten monetary policy more aggressively. However, for the Japanese government, tighter monetary policy invites greater scrutiny on fiscal sustainability. Japan has the highest public debt burden amongst major developed economies, and rising government bond yields increase debt-servicing costs.
Investors have been able to borrow cheaply in yen and invest into higher-yielding assets – known as the yen carry trade – for many years. This was effective under a backdrop of low Japanese interest rates and a stable or modestly weakening yen. But, if the BoJ hikes rates and Japanese bond yields rise further, the economics of the trade begin to deteriorate.
If such positions are broadly unwound, investors must sell foreign assets and buy yen, leading to a stronger currency and pushing yields on debt issued by other developed market governments and corporates higher still. Japanese investors are among the largest overseas holders of US Treasuries, European sovereign bonds and global credit.
Another key factor driving global bond market unease is the trajectory of government spending. Not least the financing of higher defence spending. As the Autumn Budget nears, UK investors are watching to see how the Treasury seeks to finance this within its fiscal constraints. Renewed Argentine sabre-rattling over the Falkland Islands, and news that cost pressures have seen non-essential Army training exercises suspended, brought the issue into greater focus last week.
The UK Government's Defence Investment Plan (DIP) commits almost £300bn over the next four years. Chancellor John Healey – who resigned as Keir Starmer’s Defence Secretary in protest at the inadequacy of the DIP – is set to outline plans to fill a funding gap in the plan when he delivers the Budget on 28 October. However, Healey has stopped short of explicitly committing to increase defence spending to 3% of GDP by 2030, despite suggesting that the target was imperative in his resignation letter. It had previously been earmarked as a key milestone en route to fulfilling the NATO obligation to reach 3.5% of GDP by 2035.
Healey has now promised clarity on reaching the NATO commitment at next year’s Spending Review. Nevertheless, the Autumn Budget will be watched closely for clues as to whether the Burnham government favours higher borrowing, tax rises or spending cuts elsewhere.
As was the case for the Starmer-Reeves administration, managing the fiscal headroom will prove challenging. Debt interest costs now exceed £110bn annually, and rising bond yields mean the burden could well increase. Capital spending is also bound by the investment versus debt fiscal rule, that public-sector net debt needs to be falling as a share of GDP by the end of a rolling forecast period (assessed by the OBR). The DIP principally reallocated capital budgets from other departments to fund the investment. But the OBR estimates that reaching the NATO target will ultimately amount to tens of billions of pounds in additional spending each year.
As with other firm spending commitments, tax rises and/or cuts to current spending are likely required if it is to be met without further undermining market confidence. But, with an ageing population and weak productivity growth, several factors are converging to add ever greater pressure on the public purse.
The US economy added 162,000 jobs in July, well ahead of analysts’ forecasts of 55,000 and underscored by upward revisions to the last two months’ data. On average, over 71,000 new jobs have been created monthly since May. The print spurred President Trump to demand central bankers to lower interest rates on social media, saying: “A STRONG COUNTRY MEANS A LOWER INTEREST RATE – IT’S A BETTER CREDIT – VERY SIMPLE!”
In fact, a strong labour market could support the case for rate hikes. But Fed chair, Kevin Warsh, knows that the labour market is resilient, and the latest data releases are unlikely to have a major impact on the Fed’s next rate decision. Warsh and his peers are more concerned about inflation. The bond markets (as above) are arguably sending the same message. All eyes, then, on the next inflation print on 11 September. The odds of a rate rise crept up to 60% from 50-50 before the jobs report.
Meanwhile, Canada’s economy shed 41,000 jobs in July, encouraging US Treasury Secretary Scott Bessent to contrast its data with America’s. He stated that the US economy is “not just being driven by the AI building boom”, as evidenced by the “blowout” labour report.
Disclaimer
Past performance is not a reliable indicator of future returns. Nothing herein should be construed as a recommendation to hold, buy or sell any security or encourage any investment decision. The mention of any particular asset class, sub-asset class or company does not imply that it is held, or may ever be held, in any product or service.
Before you invest, make sure you feel comfortable with the level of risk you take. Investments aim to grow your money, but they might lose it too.