Spiking interest rates on the UK government’s borrowing costs have set off a fresh wave of commentary on the health of Britain’s economy. Ali Lyon explores why it is only long-dated bonds where tremors have been most pronounced, and why the U has plenty of company.
What will you be doing in 30 years’ time?
It’s a question to which most of us rarely – if ever – devote much serious thought. Indeed readers of a certain vintage may want actively to avoid chewing over what awaits them in 2055.
But for the economists and fixed income specialists who lurk in the arcane world of sovereign debt and government bonds – coming to educated, dispassionate guesses on the long-term trajectory of the world economy is a professional obligation.
And last week we saw those investors aggressively pare back bets on long-dated government bonds – effectively 10- or 30-year IOUs issued by governments to investors – after a one-two combination of political shocks stoked unease around governments’ economic discipline.
First, we saw France’s embattled Prime Minister, Francois Bayrou, call a snap vote of no confidence in his minority centrist government, after a succession of opposition parties confirmed they would not vote through his austerity-lite Budget.
Hours later, Donald Trump issued a stunning broadside on the Federal Reserve, accusing governor Lisa Cook of falsifying her mortgage statements in a bid to replace her with a rate-setter more amenable to his demands for faster rate cuts.
Despite the Federal Reserve and Cook’s robust counterattacks to the salvo from the White House – and France rarely making the weather in the global economy – nerves coursed through the world’s sovereign debt markets.
A historic week for the bond market
‘When America sneezes, the whole world catches a cold’, is a truism that borders on cliche. But – as the name would suggest – truisms are, by their definition, true.
The yield on 30-year US Treasuries rose as much as six basis points in the immediate aftermath of Trump’s attack. But jitters were also evident in Asia and Europe. Interest on Japan’s 30-year government bonds returned to an all-time high set earlier in the week. And in the UK, where a bleak fiscal position and growth outlook renders its bond market especially vulnerable to macroeconomic crosscurrents, 30-year gilt yields approached the highest they have been this century.
Usually those moves would be matched with similar – albeit less extreme – shifts in the interest rates paid on shorter dated bonds too. You will often read word-count-restricted journalists and jargon-loving analysts talk about yields rising “across the curve”. This means the interest on government bonds is jumping in lockstep, irrespective of whether the IOUs were due to be paid back in two months, two years, 10 years, or 30 years.
Long-term borrowing costs spiking will cause a headache for the Treasury as the Chancellor prepares her second major Budget
Over the past few months, however, long- and short-dated government bonds have become increasingly unmoored, and the spread – the difference in percentage terms between yields ‘across the curve’ – has been getting wider (this is also referred to as the curve getting steeper).
Neither of those phenomena suggest investors are flush with confidence about politicians’ capacity for prudent economic policymaking. And both were evident in the immediate aftermath of France’s fiscal coughing fit, and Trump’s central banking broadside.
While 30-year bonds were selling off globally, prices of two-month bonds – which move inversely to yields – rose. This week in the US, the spread between the two bonds equalled their highest since Trump’s market-shattering Liberation Day speech. Similar patterns were evident in the UK, Asia and much of Europe.
This is not unprecedented. The spread between short and long bonds was very wide during the low-rate, quantitative-easing fuelled period following the financial crisis, as investors priced in an inevitable return to more conventional borrowing costs in the long run. But – as last week’s drama showed – yield curves are steepening again. And with interest rates considerably higher now than in the post-GFC decade, that is more of a cause for concern now than it was then.
But getting into what it says about investors’ long-term predictions for the global economy, it would be sensible to explore why this pattern is occurring in the first place.
Mind the gap
“Short dated bond yields are more anchored by base rates [the rate set by central banks], which have generally been falling in most countries over the last year,” says Thomas Pugh, chief economist at audit specialist RSM. “However, longer-dated yields are much more influenced by long-term inflation expectations and concerns about the sustainability of fiscal policy, both of which have been rising recently.”
The ongoing French political imbroglio, and Donald Trump’s bid to exert greater control over the Fed, satisfy the conditions cited by Pugh that drive longer-dated yields to spike. Bayrou’s inability to push through a more frugal Budget is the latest in a long line of western governments unable to keep a lid on their spending plans. The UK spent 5.4 per cent more than it earned between 2024 and 2025, and several failed recent attempts to keep a lid on its welfare bill show France is ploughing its furrow with plenty of company.
This pattern makes lending to countries more risky; governments that constantly spend more than they receive in tax while growing at below two per cent a year will run out of road eventually. But simple laws of supply and demand also dictate that excess supply of long-dated bonds will further push their price down, and their yield up.
A less independent Federal Reserve will mean one thing: greater pressure on the central bank to lower interest rates in the US
In the US, a less independent Federal Reserve will only mean one thing: greater pressure on the central bank to lower its benchmark interest rate (or, once they come down, keep them lower). This, in turn, heightens the risk of another bout of inflation, perturbing investors from longer bonds, as sustained price rises will eat into their returns.
Governments have been counteracting the lower demand for long-dated debt by restricting supply. In the US, Treasury secretary Scott Bessent accused his predecessor Janet Yellen of manipulating the bond market by issuing more short-dated debt than longer bonds. But since entering the same office, he has done exactly the same thing.
Closer to home, the Bank of England was forced to delay a sale of long-dated debt in the aftermath of April’s ‘liberation day’ because of market turmoil. And several economic heavyweights – including former rate-setter Michael Saunders – have recently predicted the Bank may be forced to end the sales of 30-year gilts that form part of its quantitative tightening programme altogether because of low demand.
Helen Thomas, a political economy analyst at Blonde Money, believes the trend of government front-loading their debt, just means “storing up problems when refinancing looms”.
“The UK in particular can hardly afford yields ratcheting higher at precisely the moment when it is most reliant on investor confidence,” she adds.
With a pivotal Budget looming, such a sticking-plaster approach to borrowing will aid, but not cure, an unenviable fiscal position for a Chancellor under to reinstate the fiscal headroom she left herself in the spring.
As ING’s developed markets economist in the UK, James Smith points out: “Any rise in bond yields does mechanically lower the amount of fiscal headroom it is likely to have in November.”
Central banks aggravating spreads
All the while – as Smith’s colleague, ING European rates strategist Michiel Tukker observes – the quantitative tightening policies adopted by central banks are fuelling supply of long-dated bonds, further steepening the curve.
“As central banks unwind their bond portfolios, markets have significant supply to absorb, pushing up yields,” he tells City AM. “The UK is following a relatively rapid pace of quantitative tightening, but also the US, eurozone and Japan are adding significant supply pressures.”
How will this end? Tukker’s base case is for 30-year yields “to steady at higher levels than before”.
Meanwhile Blonde Money’s Thomas believes “a quick return back to normal is unlikely while inflation doubts and policy volatility persist”.
Bayrou could yet pull off a shock political coup and push through his cost-cutting budget. Lisa Cook and her colleagues at the Federal Reserve may well withstand the barbs being lobbed at them from the White House.
But – as Tukker and Thomas suggest – the overall direction looks charted, even if, in 30 years’ time, we’ve forgotten who Francois Bayrou and Lisa Cook are and the trend their respective snafus has helped accelerate.