Global Government Bond Yields Surge Amid Persistent Inflation and Fiscal Pressures
Discount Bank economic department head Einat Meir reviews global bond yield surges, highlighting rising inflation fears, oil price shocks, and shifting fiscal pressures in the US and Europe.
Einat Meir, head of the economic department at Discount Bank, has published an economic review focusing on the sharp rise in yields on government bonds.
The sharp rise in global government bond yields continues, breaking new records amid high volatility and uncertainty. The yield on 10-year US government bonds has risen by over 1% since the beginning of the year, reaching 5.3%, the highest level since 2002, while the yield on French government bonds has risen to 4.8% with a sharp widening of spreads over German bonds.
Despite the perception that rising yields stem from concerns over high government debt levels, most of the global yield increase is driven by inflation fears and rising interest rate expectations, further supported by large debt issuances from technology companies that reduce demand for government bonds. However, in recent weeks the driving forces have been shifting, creating divergence among nations, making it crucial to understand these forces to forecast market trends.
The renewed rise in oil prices starting in July has amplified inflation concerns. However, the primary worry is that higher oil prices, combined with a prolonged supply shock, will cause price increases to spill over into other sectors beyond those directly influenced by oil, keeping inflation elevated for longer and forcing central banks to maintain high interest rates.
Inflation fears have driven up interest rate expectations and pushed yields higher across the entire yield curve, flattening the curve as short-term yields rose more sharply.
Conversely, investors have not demanded a higher risk premium on long-term bonds, supporting the assessment that the rise in yields across most markets through mid-September did not stem from concerns over government debt stability. However, in recent weeks, market divergence has grown, and yield curve slopes in the US and Germany have begun to rise again due to sharper increases in long-term yields.
High government debt is not a sufficient condition for a sharp yield spike, and typically requires an additional trigger, such as political instability, a weak investor base, high investor leverage, or low liquidity.
Despite the US government's high deficit and debt, American government bonds differ from others globally due to their status as a risk-free asset, the world's largest and most liquid debt market, and the status of the US dollar as a global reserve currency, granting the US government greater flexibility in debt management.
Furthermore, we have not seen a widening of spreads between long-term bond yields and interest rates implied by forward contracts for similar periods—an indicator of risk to government debt stability. The stable spreads indicate that the rise stems from interest rate risk, driven by the difficulty of predicting oil price developments amid ongoing conflict and the resulting uncertainty over the pace of rate hikes, rather than fears over debt stability. Meanwhile, the US dollar continues to strengthen globally due to widening interest rate differentials in its favor, and there has been no flight of investors from US assets.
At the same time, data points to rapid economic activity in the US, meaning the economy cannot be relied upon to moderate inflation or slow US rate hikes. Estimates suggest that the long-term neutral interest rate in the US is higher than previously anticipated, driven by significant investments in AI and labor market stability, supporting a higher yield environment over the long term.
Inflation and Global Market Shifts
Additionally, while for a long period following the global financial crisis US government bonds served as a hedge against stock market risks, inflationary pressures undermine the advantage of US government bonds as a risk-diversification tool.
In our assessment, once geopolitical tensions ease, leading to a decline in oil prices, there is significant room for a drop in long-term US government bond yields.
In the euro area, by contrast, the spread of government bonds over German bonds is determined by a combination of concerns regarding government debt stability and political risk. Consequently, upcoming elections in France, Spain, Italy, and Greece will command significant attention.
The rise in French government bond yields has driven a sharp widening of the spread over German bonds to a record 1.3%, higher than levels seen during the eurozone debt crisis and exceeding the spreads of Italian and Greek government bonds.
Recently, the French government updated that its 2026 deficit will exceed targets, and the 2027 budget projects a 5% deficit, a level expected to drive further increases in government debt. A lack of commitment to budget cuts, combined with high political uncertainty surrounding upcoming elections, has fueled the widening spread and threatens the stability of French government debt.
It is premature to expect intervention by the ECB in the French bond market, both because the government deficit exceeds the eurozone target—compliance being a precondition for ECB intervention—and because, despite the widening spread, it remains below historical crisis levels seen in other eurozone nations.
Despite concerns and widening spreads, the situation remains far from the 2011 eurozone debt crisis, where contagion effects among eurozone member states were significant, primarily because the ECB possesses mechanisms allowing for targeted intervention in the government bond market under specific conditions.
