Bonds are flashing red

Bonds are flashing red

In this week’s video insight I discuss why the bond market is setting off warning signs for investors, policy makers and the economy.

Last week we saw declining demand for long-term bonds and rising term premia. We are also seeing a structural shift from the way debt is issued – from long term to short term bonds.

As the bond markets get increasingly more volatile investors are looking at less volatile options, such as private credit.

View part two here. 

Transcript:

Hi I’m Roger Montgomery and welcome to this week’s video insight.

Today we’re diving into the bond market – and why it’s flashing red for investors, policymakers, and the economy alike. Yields are rising. Term premia (the additional return investors demand for holding a longer-term bond) are surging. And underneath it all? A structural shift that could upend how global markets function.

Last week, U.S. Treasury yields surged again – back to levels that have historically triggered market turmoil. The 30-year yield punched through five per cent — the highest since October 2023. The 10-year climbed to 4.59 per cent matching levels that previously forced even Donald Trump to back off tariff escalation. And what caused it? It was a lackluster auction of 20-year bonds, where demand was soft – a red flag in itself.

And behind this, a bigger storm is brewing: investors are losing appetite for U.S. Treasuries just as Washington prepares to unleash another flood of debt.

The U.S. government is staring down a fiscal cliff. U.S. President Trump’s proposed tax bill, if passed, could balloon the deficit by trillions over the next decade. Moody’s is already reacting – downgrading America’s credit rating, citing the “increasing burden of financing the deficit.”

The Republican-controlled House has passed Trump’s “One Big Beautiful Bill Act” but the Senate debate may produce changes. If enacted as currently drafted, the House’s bill would make permanent Trump’s 2017 tax cuts, while adding new tax breaks for tip income, overtime pay and older Americans, among other provisions. If it passes the Senate as is, expect even more debt issuance. And more debt, in a market where demand is faltering, means one thing: higher yields.

And the other reason yields rising so sharply – term premia. This is the extra return investors demand to hold long-dated bonds. According to some researchers, since 2010, term premia have accounted for 95 per cent of the movement in 10-year Treasury yields – up from just 47 per cent historically. And the trend is getting worse. It’s being driven not by inflation alone, but by imbalances in global liquidity, collateral availability, and changes in how governments fund themselves.

Think of term premia as the market’s barometer of risk, uncertainty, and supply-demand dynamics. And right now, it’s rising – fast.

Perhaps more worryingly, as demand for U.S. bonds softens, the U.S. Treasury may no longer be a price-setter in the bond market. It may become a price-taker. Global bond markets – especially Germany and Japan – are pushing yields higher, and the U.S. is simply reacting.

A major reason is the shift in how the U.S. issues debt. Instead of locking in low rates with long-term bonds, Treasury has been stuffing the market with short-term bills. That might look smart in the short run, but it leaves America dangerously exposed to rising short-term interest rates.

Meanwhile, long-term investors – pensions, insurers – are left chasing scarce 10-year bonds, driving prices up and artificially suppressing yields. That’s creating a dangerous illusion of stability.

There’s another consequence: banks are stepping in to absorb short-term debt, effectively monetizing the deficit. That’s a fancy way of saying government spending is increasingly being financed by money creation – and it’s not just the U.S., Britain and Japan are heading down the same road.

This is what some call ‘Yellen-omics’ – fiscal dominance dressed as monetary policy. And history tells us: it never ends well.

All this is already filtering through to consumers. Inflation expectations, as measured by the Michigan survey, are surging. Bond markets are sniffing out trouble, even if the Federal Reserve isn’t ready to admit it.

And if term premia keep rising, the Federal reserve won’t be able to cut rates – even in the face of economic weakness. Yields of 5-6 per cent on the 10-year could become the new normal… unless a recession forces a reset.

So where does this leave you? Bonds are increasingly volatile. Yields are being pushed by structural forces – not central bank policy. And inflation risks are rising. In that environment, investors are understandably looking for protection.

While some investors are turning to gold and Bitcoin, I think it’s worth considering private markets such as private credit. The message from the bond market is clear: the age of easy money could be over, and the cost of government debt is rising – fast.

If you’re watching the bond market, you’re watching the truth. And right now? That truth is getting more expensive.

If you found this analysis useful, don’t forget to like, subscribe, and share with anyone who still thinks bonds are boring. And don’t forget to follow us on Facebook and X.

MORE BY RogerINVEST WITH MONTGOMERY

Roger Montgomery is the Founder and Chairman of Montgomery Investment Management. Roger has over three decades of experience in funds management and related activities, including equities analysis, equity and derivatives strategy, trading and stockbroking. Prior to establishing Montgomery, Roger held positions at Ord Minnett Jardine Fleming, BT (Australia) Limited and Merrill Lynch.

He is also author of best-selling investment guide-book for the stock market, Value.able – how to value the best stocks and buy them for less than they are worth.

Roger appears regularly on television and radio, and in the press, including ABC radio and TV, The Australian and Ausbiz. View upcoming media appearances. 

This post was contributed by a representative of Montgomery Investment Management Pty Limited (AFSL No. 354564). The principal purpose of this post is to provide factual information and not provide financial product advice. Additionally, the information provided is not intended to provide any recommendation or opinion about any financial product. Any commentary and statements of opinion however may contain general advice only that is prepared without taking into account your personal objectives, financial circumstances or needs. Because of this, before acting on any of the information provided, you should always consider its appropriateness in light of your personal objectives, financial circumstances and needs and should consider seeking independent advice from a financial advisor if necessary before making any decisions. This post specifically excludes personal advice.