I will begin by apologizing for this week’s title.  I suppose the relentless rain has me thinking of the UK (or Vancouver, right Ally).  Well, the other place where the sun hasn’t been shining much of late is in fixed income land. If the bond market were a dinner party, the long end of the yield curve just stood up, tapped its wine glass, and cleared its throat. Investors—once lulled into complacency by years of ultra-low interest rates—are suddenly paying attention to something they haven’t had to worry about in a decade: term premiums, sovereign debt sustainability, and a gnawing suspicion that we may be entering a world where “higher for longer” isn’t just a central bank catchphrase but a structural shift.

 

This week, the U.S. 30-year Treasury yield marched past 5%—levels not seen since October 2023, when we were showed that the bond carnage of 2022 wasn’t quite over. But this isn’t just an American phenomenon. Across the G7, long bonds are throwing tantrums, and the messages are loud: “We don’t believe your fiscal discipline,” “Inflation isn’t dead yet,” and “You’re going to have to pay us more to borrow long.”

 

 

For now, the U.S. treasury market is still the el primo in the world, which means it’s hard for it to get a cold and not have an effect on other regions. As you can see from the above chart, long-dated government paper across the major markets have had a bad year. Well, a really bad five years when you think about it. The U.S. yield has gone from around 1.5% to north of 5%.  The UK has seen its long-bond yield deteriorate from below 1% to the 5.5% area and Japan – yes, the country of boringly low inflation and interest rates has gone from around the same base to north of 3%.

 

In 2022, investors were shocked as to how aggressively bond yields moved. Then, the worst correction in almost half a century was sparked by the post-pandemic surge in inflation and required monetary response. I refer to this period as an organic phase for the bond market. While the excess demand conditions created by central bank rate cuts and government handouts doesn’t look organic, we were in a state of where we thought everything had to be thrown at the problem for survival. Today is different and so are the forces driving capital flows. Yes, the disruptor-in-chief and creator of Trumpnonomics gets to take much of the credit for it.

 

Remember when we came out of 2022 and your neighbour bragged that she was getting a better rate on her short-term GIC than your long Canadian government bond? The same conversation was happening in Buffalo. In other words, restrictive monetary policy initiatives caused the yield curve to invert, meaning short-term rates rose above long-term ones. 

 

 

The above chart shows the so-called yield curve for the U.S. This is simply a graph of the yields on U.S. government securities (T-bills and bonds) at a specific point in time. In this case, we are comparing the shape of the curve last year to now. The difference couldn’t be more stark. Back last year, you could still get short-term paper with a 5% plus handle and be offered a 4.5% yield on longer-dated paper. Today, I can get a little less than that on a short-term investment but receive 5% plus further out the curve. Typically, we refer to this as a normally-shaped yield curve, where investors are paid more the longer the maturities they invest in.

 

Some believe that the era of yield curve suppression is over and we are entering the “great repricing”.  In real estate, we are used to talking about a buyer’s or seller’s market. We are firmly in the former today folks. And the best way to gauge this is buy examining what we call the “term premium” – the additional bang for the buck we demand for giving Uncle Sam our money for say 10 years than 3 months. For the past decade, the term premium was something like the Loch Ness Monster—discussed often but rarely seen. But now, it’s back and making waves. According to the NY Fed’s ACM model, the term premium on the U.S. 10-year Treasury has surged above 70 basis points for the first time since before the pandemic. This reflects mounting concerns about long-term inflation, debt sustainability, and the end of artificial demand from central banks and foreign buyers.

 

 

The surge in term premiums is driven by three big forces: persistent fiscal deficits (even during full employment), sticky services inflation, and a supply glut in bonds as quantitative easing unwinds. In short, investors want to be paid for taking long-term risk again.  The NY Fed puts together an estimate of this premium, which we show in the chart above. First of all, the period from 2015 to 2020 was abnormal.  Economic fractures caused by Trump 1.0 policies and then the pandemic created a distortion in term premia and I would go so far as to say that this distortion led investors (and institutions) to orient their balance sheets in such a manner that they were not only undercompensated for term risk, but were as vulnerable as an ill-prepared visitor to the Oval Office.

 

This move reflects growing unease over America’s fiscal trajectory. Last Friday I had no sooner sent out the newsletter then Moody’s announced that they were stripping the U.S. of its triple-A credit rating. Sure, this lagged the same decisions taken by S&P and Fitch a while ago, but it has caused investors to sit up and wonder how many more shoes are going to drop. This week’s 20-year Treasury auction was a flop, with a high yield of 5.05% and lackluster demand. Dealers were forced to absorb a greater share of issuance, a potential warning sign that investors are beginning to question the long-term creditworthiness of even the world’s reserve currency issuer.

 

As mentioned above, it’s not just the U.S. that is experiencing an updrift in long-term bond yields. The pressure on borrowing across other nations is a direct result of the policy vortex injected by the White House in recent months. Whether it is the increased spend on military, or the defensive and protective policy initiatives against the negative growth implications from tariffs, inflated fiscal deficits have become the, at least temporarily, new normal. That said, we believe that developed nation economy fiscal risks are relatively lower than the U.S.

 

 

We do expect the U.S. economy to pay an economic price for its charted course and antifipate that this price will be slower to negative growth, lower inflation, and lower short-term interest rates.  For one, the rise in long-term U.S. bond yields is potentially going to push mortgage rates and other lending costs higher. This may not result in a U.S. housing correction, but could stifle growth. At some point, the Federal Reserve will need to step in to protect the country from falling off the cliff – following what other nations are already doing in a proactive manner. In other words, a steepening bias towards the U.S. curve remains the best strategy in our opinion.

 

 

If foreign capital flows gravitate to longer-term bonds outside of the U.S., this should limit steepening in those regions, unless economies really fall off the rails. On that note, I believe that we can start to venture out to the longer end of not only the Canadian yield curve, but some foreign markets as well. As you can see from the chart above, showing the curve today versus where we were a year ago, there has been a dramatic steepening, but this has stemmed from lower rates at the front-end of the curve. In fact, the 20-year yield today is pretty much where it was last year.

 

Bottom line. Domestic and international bond investors are no longer asleep. They are alert, caffeinated, and increasingly skeptical of the fiscal horizon. Still, for some markets we are beginning to see opportunities for not only higher on the run coupons, but capital appreciation as well. Similar to 2022, we not only need to pay strategize on the equity side of the portfolio, but make sure we are protecting on the fixed income side of the ledger as well. This road is going to be winding for sure.

 

On behalf of the Pyle Wealth Advisory team, have a wonderful weekend.

Andrew Pyle