Bond Yields Rise as Markets Expect Higher Rates for Longer

Government bond yields have surged in major economies, but the usual explanations, rising public debt or 1970s-style inflation, don't fully hold up. David McLeish, Chief Investment Officer of Wedge Management, argues that the real driver is simpler: markets adjusting to the reality that short-term interest rates will stay higher for longer.

The so-called "buyers' strike" theory, especially popular in the U.K., suggests investors are demanding higher yields due to concerns over public debt. However, data shows that Gilts (U.K. government bonds) are trading at similar valuations relative to interest rate swaps as before the sell-off. Additionally, short-term bonds have taken the brunt of the hit, not long-dated debt, which contradicts fears of long-term fiscal insolvency.

The inflation theory also falls short. While U.S. inflation has remained above the Federal Reserve’s 2% target for 67 consecutive months, core measures are moderating, and forward-looking inflation swaps stay below 2.5%. Instead, McLeish points to two key factors: geopolitical conflicts disrupting supply chains and keeping commodity prices high, and massive capital expenditure in AI infrastructure boosting economic growth.

McLeish warns that misdiagnosing the cause of rising yields could lead to incorrect responses. He argues that high global yields are a return to a healthier financial system where capital carries a real cost, rather than a sign of impending doom.