Making It Real: What the Bond Market is Telling Us

Given the choice between owning a 30-year U.S. Treasury bond OR Amazon shares for 30 years, what would you pick?

I was on a panel in Frankfurt recently when an investor's answer to that question captured where we are in bond markets. His response – Amazon – shows that investors are questioning what return they should demand to lend money for a long period of time, and how government debt compares with other global investment alternatives.

For some time, the fiscal outlook for many developed economies has been a back-burner issue for markets. Increasingly, it has moved to the forefront. Investors are looking at government spending trajectories, the amount of debt being issued and what higher interest rates mean for the cost of servicing that debt over the next several years.

At the same time, central banks have shifted more hawkish as inflation remains a concern. Geopolitical conflict is adding to uncertainty around the inflation outlook, including energy and, in some emerging markets, food prices. Put all of that together and investors are demanding higher yields to hold government debt.

The mechanics are relatively straightforward: when investors demand a higher return to own a bond, its price falls and its yield rises.

You hear a lot about the U.S. 10-year Treasury yield crossing particular levels. There’s nothing magical about 5% versus 4.99% or 5.01%. The bigger question is what happens when rates stay higher. Governments face higher interest costs. Companies face higher financing costs. And ultimately it filters through to the broader economy, including mortgages and other forms of credit.

For our clients, the question quickly becomes: What do I do about it?

If you’re a corporate CFO who needs to raise money, there are a series of decisions to make. Do you issue now or wait? Where on the yield curve do you issue? Do you fund in dollars or could you issue in another currency and swap it back more cheaply? Will significant long-dated issuance from hyperscalers affect demand for your bonds?

We advise clients on all of those decisions. We help them think about where they can access liquidity, how they should finance themselves and whether they should hedge their exposure. 

And behavior changes as markets move. During periods of intense volatility, corporates may sit on the sidelines and then come back when conditions improve. Some investors run less risk or trade more tactically because there is less conviction about the fundamental direction of markets. At other times, forced selling or hedging can create dislocations and opportunities.

That is why we don’t look at one number in isolation. We watch daily volatility, how volatility itself is being priced, funding markets, expectations for central-bank action and what is happening across credit, currencies, equities and commodities.

Ultimately, the bond market is giving you information. It is telling you how investors view the outlook for inflation, growth, debt and risk relative to other places they could put their money. Our job is to listen to what the market is telling us, understand what it means and help our clients decide what to do next.