As the 10-year US Treasury yield breaks above 5% and Japanese bond yields fall below 3%, global bond market pressure surges!

The global bond market is undergoing its most severe test in decades. The 10-year U.S. Treasury yield has surpassed 5%, reaching its highest level since 2007, while Japanese government bond yields have also risen above the 3% mark, hitting the highest level in 30 years. A triple combination of surging energy prices, persistent high inflation, and the ever-expanding scale of sovereign debt is further intensifying the sell-off momentum in the global bond market.

During Tuesday’s Asian trading session, the 10-year U.S. Treasury yield climbed to 5.02%, hitting a new high since 2007 for the second consecutive day. Meanwhile, Japan’s 10-year benchmark government bond yield rose to 3.03%, also marking a 30-year high. Both the Federal Reserve and the Bank of Japan are facing rate decision windows this week—market consensus expects the Fed to raise interest rates, while the Bank of Japan is also anticipated to hike rates to the highest level in 31 years. Market sentiment remains fragile, and any deviation in policy signals could trigger another wave of shocks.

This round of global bond market sell-off isn’t driven by a single factor. The immediate trigger for the persistent rise in yields is the surge in oil prices caused by escalating tensions in the Middle East—Brent crude rose 1.6% during Asian trading to $107.3 per barrel. At the same time, corporates are issuing large amounts of debt to fund AI-related expenditures, flooding the market with bonds and continuing to inject stimulus into an already resilient U.S. economy.

From a deeper, structural perspective, governments’ debt issuance continues to expand, needing to refinance maturing bonds while also funding fiscal deficits. With major central banks exiting their quantitative easing programs and government bond buying, traditional buyers are stepping back, forcing the market to rely more on price-sensitive marginal investors to absorb the supply.

Mansoor Mohi-uddin, Chief Economist at Bank of Singapore, commented, “Global government bond yields are rising as the Middle East oil shock, persistent inflation, and renewed central bank rate hikes all suppress demand.”

The pressure on Japan’s bond market is equally significant. According to Reuters, the Japanese government plans to formally approve the outline of a consumption tax reduction program this Tuesday, lowering the consumption tax on food from 8% to 1% for two years, effective from April 2027. This move will create a tax gap of about 5 trillion yen, yet the plan does not specify the source of funding, fueling ongoing market concerns about Japan’s fiscal sustainability.

Additionally, according to Bloomberg, Japanese authorities are considering setting the medium-term defense spending target at 3.5% of GDP to align with NATO allies. Westpac Banking Corp believes potential additional defense expenditure by Japan will put further pressure on the global bond market.

Keisuke Tsuruta, Senior Bond Strategist at Mitsubishi UFJ Morgan Stanley Securities, said that the market will remain uncertain until the year-end budget draft is approved by the cabinet. “It’s hard to predict the total bond issuance for next year at this stage, so the market is likely to stay nervous.”

5% is a closely watched round number for the market, often serving as a trigger point for both investors and policymakers. The 10-year Treasury yield briefly broke this level on October 23, 2023, and again on Monday of this week, but did not close above 5%—the last close above 5% occurred in 2007.

The implications of this level for broader asset markets should not be underestimated. A yield of 5% means investors can lock in a 5% annualized risk-free return for the next decade, potentially diverting funds that would otherwise go to equities. Jesse Marre, Senior Portfolio Manager at Hilbert Group, commented, “Once we break 5%, risk assets start to become a concern.”

Padhraic Garvey, Head of Research for the Americas at ING Groep NV, outlined an even more sobering scenario: “Could things get worse? Yes. Once the 10-year yield convincingly breaks above 5%, 6% will come into focus for the market. And the journey from 5% to 6% will be far more difficult for the broader market to digest than anything that has come before.”

The market’s current primary focus is the Federal Reserve’s interest rate decision this week.

Vail Hartman, strategist at BMO Capital Markets, noted that if the Fed stands pat, its inflation-fighting credibility may erode; but if it raises rates, yet Chair Powell sends a dovish message at the press conference or in the dot plot, bond investors may still demand higher yields to hedge inflation risk.

Martin Whetton, Head of Financial Markets Strategy at Westpac, said: “A Fed rate hike combined with persistently higher oil prices will again push up U.S. yields. The move to test 5% during Monday’s session should be seen as the norm rather than an exception.”

Phoebe White, Head of U.S. Rates Strategy at UBS Group, pointed out that the upside for long-end yields is limited. She noted there is no clear sign of weakness in the real economy yet, and that the supply-demand dynamics of the U.S. Treasury market have changed significantly since 2007, with “structural demand from institutional players such as foreign official investors having materially weakened.”