Global bonds are reeling as oil surge rekindles inflation threat

Global bonds were pummelled this week by the latest resurgence in energy prices, delivering losses to investors who bet the worst of this year’s rout was over and teeing up credibility tests for central bankers.

UK gilt yields this week set their longest period of daily closes above 5 per cent in almost two decades, while Germany’s 10-year yield climbed to the highest since 2011. Japan’s 40-year yield jumped 10 basis points on Friday alone. The US 30-year yield grazed just below its highest levels since 2007.

Such is the extent of the selloff that the average yield on the Bloomberg Global Treasury Index, which tracks government bonds of investment-grade countries, surged to 3.68 per cent on Thursday, surpassing a peak from three years ago to reach the highest since the global financial crisis in 2008. The benchmark is set for its biggest monthly loss since March.

The simultaneous pressure on both front- and long-end yields comes ahead of another week that could move the market. While US Treasury yields trimmed some of the week’s surge in Friday trading, investors will still turn to key central bank decisions due next week from the Federal Reserve, Bank of Japan and Bank of England.

A further selloff in bond markets would add to concern that global debt levels are becoming unsustainable, push up global corporate borrowing costs and risk spurring a rotation away from stocks. 

“There are many of the same forces at play,” Torsten Slok, chief economist at Apollo Global Management Inc. in New York, said of yields rising across sovereign debt markets. “Oil prices are going up. That creates problems for the Bank of England, that creates problems for the Fed and, by the way, also creates problems for the European Central Bank.”

Global debt markets have been battered this year by surging energy prices caused by the conflict in the Middle East. Crude tumbled in June as a ceasefire between Iran and the US appeared to take hold, but renewed hostilities sent oil prices higher again this month — with Brent on Thursday climbing above $100 a barrel.

The bond market has also been pressured by US economic resilience, manifesting in solid jobs and growth figures. That’s helped shift the expectation for Fed monetary policy this year from cuts to hikes.

Traders are also coming to grips with Chairman Kevin Warsh’s revamp of Fed communications designed to provide less forward guidance — raising the prospect that any change in policy may come sooner than anticipated. Bets on a rate increase at the Fed’s July 28-29 policy meeting have risen, with the market-implied probability now standing at a one-in-three chance.

“We know that Warsh does not want to provide the market with forward guidance, which is fine,” said Mark Cabana, head of US rates strategy at Bank of America. “But then the market has greater ability to price the outcome that it thinks the Fed should do, or price an outcome that perhaps will force the Fed to consider hiking.”

The reduction in forward guidance from the Fed may mean its next decision may be a surprise whichever way it goes. The ICE BofA MOVE Index, which estimates bond-market volatility and is a reflection of this uncertainty, advanced to a two-month high on Thursday.

More than anything, Warsh and his colleagues need to convince the market that the central bank has inflation under control. Bond funds are still reeling after global policymakers were caught off guard by the surge in price pressures following the coronavirus pandemic. Bloomberg’s global bond benchmark remains about 20 per cent below its peak set in early 2021.

“A hike would push the market to reassess the terminal rate higher, flattening the yield curve,” analysts at Barclays Plc including Anshul Pradhan wrote in a research note on Thursday. “An on-hold decision, if not explained well, could likely lead to higher long-term rates.”

Bonds are also sliding in Asia. Japan’s benchmark 10-year yield rose toward the highest since the 1990s on concern the...