Global Bond Selloff: What’s Driving the Move Higher in Long-End Yields?

Kristian Kerr (00:00):

Welcome to Market Signals. I'm Kristian Kerr, head of Macro Strategy LPL, and I'll be your host this week. We're coming off a rough week for the bond market, which had its worst weekly performance in over a year. Yields on the long end are moving higher globally with particularly sharp increases in markets like the U.K. and Japan, and in the U.S. We also notably have the first 30-year auction price above 5% in over 18 years. Let's break it down. I'm joined with my colleague Lawrence Gillum, LPL's chief Fixed Income strategist, Lawrence. Great to have you on.

Lawrence Gillum (00:30):

Yeah, great to be here. Like you said, it's been a pretty volatile week over the past week, so.

Kristian Kerr (00:37):

Should be, should be a lot to talk about.

Lawrence Gillum (00:39):

Absolutely.

Kristian Kerr (00:40):

Let's start at a high level, from your perspective what's really driving this broad-based move higher and back end yields, and what is the risk that this is the start of a larger trend in yields?

Lawrence Gillum (00:50):

Yeah, it's really interesting. So last week, if you look at the economic data, we got some inflation data here in the U.S. that was as expected, came in on the high side. Markets didn't really move around too much here in the U.S. I don't think what we're seeing here in the U.S. is simply a byproduct of higher inflation expectations. I think this really is global in nature. We saw a big selloff in global bond markets on Friday. As you mentioned, Japan and U.K. gilts were leading the move higher in yields. U.K. gilts are at the highest levels they've been since 1998 in the long end of the JGB curve, or the highest levels ever.

Lawrence Gillum (01:35):

So it's one of these things where I think that bond markets are global by design. And I think when we start to see this selloff in one market, it tends to spill over into another market. If you think about the cross ownership of Treasury securities and JGBs and other government bond securities that, these are all global in nature. So when U.K. gilts sold off as much as they did, they're the second biggest owner of Treasury securities, that's going to have a negative impact on the Treasury market as well. So I think this is just a broader concern about duration. And there is an inflation component in there for sure, and a repricing of monetary policy expectations, which is pushing out the long end as well. It's really been a perfect storm of higher inflation, more probability of synchronized rate hikes versus cuts. And then you have the issues in the U.K. about some political dysfunction as well. It was not a good week when all three of those things came together to push yields higher.

Kristian Kerr (02:43):

Yeah. Let's dive a little deeper into the foreign dynamics. We've talked about Japan and the U.K., I think long end gilts, so 30-year gilts, highest level since the late nineties. So can you speak a little bit more about what's going on in these markets in particular? I know the U.K. is very political. There's a lot of sensitivity, because the last time we were at these types of levels and yields, you had the so-called Liz Truss moment. Walk us through what's going on in Japan and the U.K.

Lawrence Gillum (03:16):

So what's interesting, the Liz Truss moment came when the 30-year gilt hit 5%. We're closer to 5.70% net right now. So we've moved really far past that Liz Truss moment, and there is that political dysfunction going on in the U.K. There's some questions about Keir Starmer's future. There's some challengers that have stepped up to challenge his position. And I think the concern there is that <laugh>, the market is looking at Starmer as a fiscal conservative versus the potential challenger, and there'd be an expectation of additional fiscal spend in the U.K., higher gilt issuance — and markets would really push back on that.

Lawrence Gillum (04:02):

I think fiscal conservative is not something that we can really use around the world these days. Because it's not really true, but it's all relative. But I think there is concern, broader concern within the U.K. that if Starmer is replaced, you'll have a new prime minister and increase fiscal spend. And that would add to budget deficits and gilt issuance. In the Japanese markets, we had some PPI data come out last Thursday, came in really hot month over month and year over year. And I think that is really forcing the hand of the Bank of Japan to raise rates. And I think that they've been hesitant to do so. And I think the markets are pushing towards further rate hikes in 2026. We have about two hikes priced in for the Bank of Japan this year. As long as these inflationary dynamics continue to worsen in Japan, I think that's going to really force the markets to push the Bank of Japan toward further rate hikes.

Kristian Kerr (05:10):

Okay. Is it fair to say the market thinks the BOJ is behind the curve?

Lawrence Gillum (05:17):

Absolutely. I think that's exactly the point. And that's why I think that the market is really going to force the BOJ to hike rates here. What's interesting though is that markets aren't pricing in a full rate hike until the July meeting. So there's still room, I think, to force a June hike.

Kristian Kerr (05:36):

Okay. Something to watch out for. I did want to circle back on the U.K. I understand the fiscal fears there, but policy is also a lot stricter than it was during the Liz Truss era. I think there's a bit of the market that thinks it's more about politics, but you can say, we would naturally be higher by at least 100 basis points just because policy is so much higher than it was. Is that a fair assessment or do you think it's just purely about the fiscal fears?

Lawrence Gillum (06:14):

I think it is fair. What we're seeing in terms of things like term premia, these are increasing globally as well. As those concerns broaden out about issuance and higher inflation volatility we've talked about term premia a lot here in the U.S., and that has started to normalize a little bit. I think it's still a little bit too low given current dynamics, but we're seeing that globally as well. Frankly, I think it's healthy to have an increased term premium globally. Investors aren't getting compensated right now to own longer-maturity securities, and until there is that additional compensation, that's not going to entice investors to buy the back end of curves. Our view is that we'll probably continue to see some steepening in these markets. If rates fall from current levels, I think it'll be primarily on the front end of curves and not towards the back end of curves.

Kristian Kerr (07:09):

Okay. Well, you're making a case that for back end yields, the path of least resistance in the near-term seems to be somewhat higher. So when you step back and look at all this, the obvious question is: what would need to happen for yields to stabilize from here?

Lawrence Gillum (07:26):

The first thing needed is some clarity around the Iran conflict. If oil prices stay around current levels or even fall a little bit, I think you're going to get some additional clarity as it relates to the inflationary story. I think what's still going to be a big issue on a going-forward basis, and we wrote about this in our outlook I think last year, is that issuance is going to be a problem for many global governments given the deficits these countries continue to run. So I think it's really going to come down to what happens with the Iran conflict. Will we see some relief at the gas pumps or not? And there are still concerns about central banks that are put in a position where I think the bar for rate cuts is starting to get a lot higher than it was, a couple weeks ago.

Kristian Kerr (08:24):

If you look at gasoline prices, we're getting really close to the 2022 highs heading into the driving season. That's a great point. If you look at 10-year yields versus December 2026 Brent crude, they're trading almost tick for tick. That really is the crux of why the inflation scare spilled over into bonds. But it really is all about oil. Another way to answer this question: you need stability in the oil market for yields to sell off, which would mean some sort of resolution with Iran and the opening of the Strait of Hormuz.

Lawrence Gillum (09:06):

Absolutely. That's certainly been weighing on near-term inflation expectations. But what's interesting is here in the U.S., the 10-year Treasury yield has risen about 66 basis points since the Iran conflict began, about 40 basis points from higher TIPS yields and real yields, with the rest a repricing of central bank policy rate expectations. Whereas only 24-25 basis points of that came from inflation expectations. So I do think that the longer this plays out that you could see these 10-year inflation expectations move higher too, which would put, again, upward pressure on the 10-year Treasury yield. It's been a big move already. I don't think we're out of the woods. That's one of the reasons why we're not big fans of owning a lot of duration in this market, or frankly, anywhere globally. So outside of munis, I think munis are a different story, but within government bond markets, there's not a lot of value in owning duration right now, as the path of least resistance remains higher for longer-maturity securities.

Kristian Kerr (10:16):

Fair enough. At what level of 10-year yields do you start thinking about buying?

Lawrence Gillum (10:23):

It's an evolving answer. I think we've talked about 4.75-5% on the 10-year as an area that would look pretty attractive. Certainly a lot depends on what happens with the Iran conflict. If we continue to see this price shock, we've talked about this: if there's an oil shock, it does take a while to feed into the real economy, but then you start to see real economic deterioration. And I think that would be an actual hedge or a tailwind for yields if that were the case. If we were to see a big increase in unemployment or steep declines in economic activity, I think that would allow the 10-year Treasury yield to fall. That takes time though. But if we did see a 4.75-5% 10-year yield, that would be a pretty attractive place to reengage with duration.

Kristian Kerr (11:23):

And when Bessent became Treasury Secretary, he said his number one job is being America's primary bond salesperson. He has talked about 5% as his North Star, so I'd take him at his word: once yields approach 5%, you're probably going to see policy aimed at bringing them down. That's a key tenet of his stated policy. I'm a little of two minds because, if you look at where bonds have been trading, you have this very tight, compressed range since the start of the year — you look at things like realized volatility and average true range.

Kristian Kerr (12:08):

We were at levels you really hadn't seen before or hadn't seen in a long time, which tends to mean a reversion toward higher volatility. It's tough because you've got that aspect. You've got a market that's getting crowded. You've got CTAs starting to get fairly short bonds, and you see this compressed range. Ignoring everything else, you could get a pretty big move toward higher yields. But then you've got the administration's stated policy of not wanting tens above five. You have that competing dynamic. Ultimately, I think the administration will do what it needs to do to put a ceiling on yields around five. Is that how you're thinking about it?

Lawrence Gillum (12:50):

It is, but then you think about what can the administration do to bring down long-term Treasury yields? They're fairly limited in terms of changing their issuance trends. They're already heavily relying on T-bills to fund these deficits. About 22% of issuance is in T-bills. The Treasury Borrowing Advisory Committee has said 20% should be the max there. So they're a bit above what their advisors recommend. I think, what's interesting is that Bessent, before he took over, he criticized the previous administration's inability to extend the weighted average maturity of debt. It doesn't look like he will. And it wouldn't make sense from a financial perspective to do that either.

Lawrence Gillum (13:35):

So maybe they could shift issuance and rely more on bills to reduce long-end supply. Outside of a new Treasury-Fed accord, I can't think of much that would bring down Treasury yields. They've talked about changing regulatory rules and have done some of that already. But we haven't seen a lot more demand come to market because of some of these regulatory changes just yet.

Kristian Kerr (14:10):

Well, something like yield curve control?

Lawrence Gillum (14:12):

<Laugh>, Those are three words you can't utter in the fixed income markets — it scares me. I think that's probably the natural solution to higher yields, and they can declare a crisis and say that the debt's too expensive. About two weeks ago, Gundlach came out and said that they're going to replace all their high-coupon debt with low-coupon debt. I don't think they can do that. I think that would result in a technical default. But outside of things like that, yield curve control is probably a break-glass type of policy where they could say that this is a crisis and that's where a Treasury-Fed accord would take place. And you have the Fed start buying a lot more longer maturity securities and keep interest rates low.

Kristian Kerr (15:06):

Let's bring in your favorite topic: equities. We do a lot of work with Vanda Analytics. They've done great work showing that when you get about a 30 basis point move in bonds over a three-month period which tends to weigh on equities — which is what we saw on Friday. Do you think that could be traced back to what's going on in yields or, when does this start to matter to the equity market, do you think?

Lawrence Gillum (15:40):

It's definitely not my wheelhouse, but I do think that, the 30-year touching 5% and staying above 5% has a big impact on equities, that's your valuation as part of your valuation component. So I think it's definitely the volatility within the rates market as well as rate levels that have risen significantly. You have a lot of these longer-duration equities that are, could potentially get negatively impacted by higher bond yields. But we're, we're down again today in on the S&P 500, about 56 basis points. So not a tremendous selloff, but, higher yields are pointing towards lower equity prices currently because of just what we've seen recently in the, in the rates market.

Kristian Kerr (16:31):

Okay. How about private credit? There were some negative headlines last week. How is that space playing into all this as yields move higher?

Lawrence Gillum (16:43):

It's a good question. We haven't really seen any transmission into the public markets yet from the private credit space. We've talked about this: if you started to see stressed private credit issuers, some managers would necessarily need to provide liquidity by selling their more-liquid assets — bank loan securities in particular, or high-yield bonds, if they own some things that are in the public markets that would allow them to come up with some liquidity pretty quickly Spreads in the high-yield, investment-grade, and bank loan markets continue to move tighter of late. We haven't really seen a lot of crossover from private to public markets. It's probably still contained at this point.

Kristian Kerr (17:48):

Let's shift gears. There are some big changes happening at the Federal Reserve. Kevin Warsh hasn't technically started yet as chairman of the Fed, but he was approved last week and will be coming in shortly as the new Fed chair. How will that affect short-term rates? Historically, new Fed chairs get tested early going back to Greenspan right after the 1987 crash. Could this be part of that test? We're in a very different environment from a few months ago, when we were talking about rate cuts; now markets are pricing in a full hike by Q1 of next year. How do you view a Warsh Fed?

Lawrence Gillum (18:45):

You do get that tendency to test new Fed chairs, differences in communication styles and philosophies play a role. Part of this bond market selloff could be associated with that. But like I said, there's so many different dynamics that are taking place right now globally within the bond market that are pushing yields higher. This wouldn't surprise me as one of the factors here in the U.S. What's going to be challenging for Warsh is the committee structure, to get rates lower, he needs seven votes. And even to change the structure or size of the balance sheet, he needs seven votes.

Lawrence Gillum (19:34):

It's going to be a challenge for him to come into this environment where a lot of the colleagues on that committee have started moving towards no cuts this year, and some have even said they wouldn't be surprised to see the next move as a hike. I still think the bar for a rate hike is pretty high at this point. But they're certainly discussing the potential for rate hikes. So you have to wonder, how much time is Trump going to give Warsh to bring down rates before we start to see some angry posts? He's really limited in his ability to do much unilaterally because he's going to need that consensus.

Lawrence Gillum (20:17):

There are 12 voting members on the committee and you need seven votes. I think he's going to have a tough time, especially now that Kugler is off the board. Christopher Waller, thought of as a dove and once in the race to replace Powell, has since moderated his views a bit. Warsh might be isolated in wanting a lot more rate cuts than the rest of the committee. And I think that's just going to make his job even more challenging.

Kristian Kerr (20:48):

Yeah. And I think one of the more interesting dynamics here is that you're going to have a former Fed chair sitting on the committee as well, does that create a shadow chair dynamic? It'll be interesting, I don't think we've ever seen that before.

Lawrence Gillum (21:05):

There was one other time: Eccles, largely considered the first modern Fed chair post the banking regulations of the thirties, the building is named after him, stayed on past his term. Most Fed chairs step off the committee when their term expires. Chair Powell has said he'll stick around until all the legal challenges are behind him. So it's an open question as to how long that'll be. Warsh hasn't been sworn in yet. He'll be sworn in at the White House, actually I think next week, perhaps the first Fed chair to be sworn in at the White House since Greenspan.

Lawrence Gillum (21:52):

I think that's symbolic in a certain way, given what Warsh has talked about in terms of regime change. In the meantime, Powell was voted in pro tempore. Powell is still effectively head of the Fed for now, and I think that will cast a sizable shadow over Warsh. Powell has done a really good job building consensus, and I think a lot of people still trust his judgment. And you have the new chair coming in talking about regime change. It's going to be an interesting dynamic. The job of Fed chair is always a difficult one. You're almost damned if you do and damned if you don't, given the dual mandate, but you also have these soap opera dynamics within the Fed that could make markets more volatile than necessary. Imagine what markets would do if Warsh says something and Powell says something completely different the next day.

Kristian Kerr (23:00):

That would send volatility up. Let's end with one final question. We've covered a lot of ground. We've got an interesting week coming up. We've got the Fed Minutes, we've got a big auction in Japan. What are the key data points you're watching in the near-term for visibility on where rates go from here?

Lawrence Gillum (23:30):

It's really those two things you mentioned. We don't have a lot of top-tier economic data this week, so we don't have to worry about jobs or CPI, and we don't have any big Treasury auctions in the U.S. either. Every time I say this I jinx myself, but I think it'll be a relatively quiet week, given we don't have a lot of top-tier U.S. economic data. But given what we've talked about, the spillovers from other markets mean things could still get volatile. And that could flow into our markets as well. I think non-U.S. data is more important than U.S. data this week.

Kristian Kerr (24:18):

I'd say quiet week, geopolitics notwithstanding.

Lawrence Gillum (24:24):

Absolutely. That's always top of mind.

Kristian Kerr (24:25):

Always a wild card right now. Alright, I think we can wrap things up there. Great insights as always, Lawrence really appreciate you taking the time to walk us through it today. Thanks everyone for listening. Please join us next week for another Market Signals. Until then, bye for now.