- Worries about the US’s debt load and Japan’s have led to recurrent selloffs in the ultras.
- Within the G3, only Germany has a more benign government debt load.
- We should also consider the cyclical aspects as economic / political dynamics shift.
Related Insights
G3 Rates: Shifting gears
Within the G3 space, bond vigilantes featured heavily since the start of the year. However, we should also consider the cyclical aspects as economic / political dynamics shift. Below we lay out our thought along these two themes.
First, bond vigilantes have been on alert thus far this year. Debt levels across the DM space is becoming elevated and historically higher level of interest rates (compared to the 2010s) are not helping. US’s spending on interest has now reached an annualized 3.2% of GDP as of April this year. Within the G3, only Germany has a benign government debt load (60% of GDP). Worries about the US’s debt load (>100% of GDP) and Japan’s (>200% of GDP) have caused recurrent against the long to ultra-long end. Notably, 30Y US yields briefly poked above 5% and came within this cycle’s high of 5.17%. Meanwhile, there has been a relentless shift higher in ultra-long end JGB yields. Bund yields have been buoyant, but we think that investors are pricing in a more optimistic economic outlook rather than factoring in a higher required rate of return for fiscal laxness.
There are several watchpoints. In the US, the non-partisan CBO has indicated that Trump’s tariffs (if kept at current levels and without considering second order impact) could bring in USD 2.8tn over the coming ten years, offsetting the extra USD 2.4tn in spending that would come from extending the TCJA. This should perhaps ease some concerns on US debt at the margin but probably means that tariffs would probably have to remain at fairly high levels. It is not clear how much of the Trump’s Big Beautiful Bill would pass. The public spat between Trump and Musk suggests vastly differing views at the administration. In the short term, at least, there is some hope that a compromise might be reached and the final bill that Trump gets to sign would be more restrained on the spending side. Monetary authorities / governments can also take some steps to cushion bond market volatility, including increasing bond buybacks (the Fed did it) or rejigging issuances away from the longer tenors (the MOF is mulling this while the UK has already done it). However, these steps only provide temporary relief. Investors need regain confidence that the DM’s have their budget under control.
Second, economic dynamics are shifting. The growth outlook is generally challenging across the DM amidst the trade war. Despite the resilience of NFP, we think that doubts about the strength of the US economy would remain. A stronger case could be made for further calibrated cuts with US inflation surprisingly well behaved thus far. Bets on rate cuts would probably keep a bid on front-end USTs. Meanwhile, the ECB has been steadily cutting rates, but with the policy rate already at 2% (at neutral), Lagarde has indicated that there may not be much room to ease further. In any case, if the tariff war stays as is and fiscal spending kicks back in, the outlook for the Eurozone may turn more positive. Lastly, the BOJ is still facing considerable inflation pressures and hence incentive to further normalize policy settings. However, the volatility of the yen and gyrations in the ultra-long tenors means a quicker rate hike path is difficult.
The upshot is that the Fed and ECB are likely to shift gears. After the extended pause, we see the Fed cutting 50bps in 2H with the market likely to demand more in 2026. The ECB may be close to done (if not already done) for the time being. Meanwhile, the BOJ remains on the slow tightening path. We see a decent chance that US yields would shift lower in the coming few months as market participants mull a US economic slowdown, further steepening the curve in the process. Meanwhile, we think EUR rates would be somewhat more buoyant. Lastly, the JGB curve may be for some flattening pressures amidst ongoing BOJ tightening and a potential tilt in issuances away from the long end, into the front to belly tenors.
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