Navigating the volatility in global bond markets

Episode Summary

Executive Summary: The episode explains why global bond yields have surged: stronger-than-expected U.S. growth and labor data, a less disinflationary Fed outlook, election-related repricing of fiscal/trade policy, and a rising term premium tied to heavy sovereign issuance and uncertainty. Both guests see volatility driven by fundamentals plus fear, but expect yields to drift lower in 2025 if inflation moderates and second-round tariff effects remain limited.

Main Topics: Drivers of the global bond selloff (Priority: 5/5): George Cole argues that the move higher in yields stems from revised expectations for growth, inflation, and central-bank policy, especially in the U.S., with spillovers to other markets. Higher term premium and Treasury supply concerns (Priority: 5/5): Both guests say investors are demanding more compensation for holding long-duration sovereign debt because of large deficits, elevated issuance, and uncertainty about future Treasury financing strategy. Fed path, rate expectations, and neutral rate debate (Priority: 5/5): Johnny Fine highlights that markets moved from pricing multiple cuts to even assigning some probability to hikes, partly because investors may think the neutral rate is higher than previously believed. Tariffs, inflation, and second-round effects (Priority: 4/5): The speakers distinguish between one-off tariff-induced price increases and broader inflation persistence, emphasizing that second-round effects appear limited so far. Corporate credit and investor behavior (Priority: 3/5): Johnny says high yields are attractive for credit investors and manageable for issuers, with spread levels still very tight and issuance activity remaining healthy. Regional divergence: U.S. versus Europe and the UK (Priority: 4/5): George stresses that U.S. growth is supporting higher yields, while Europe, the UK, and China have weaker growth, making the yield move less fundamentally justified outside the U.S. 2025 outlook for bonds and rates (Priority: 4/5): Both guests are broadly constructive on bonds, expecting yields to move lower over 2025 if inflation continues to ease and policy uncertainty becomes clearer.

Key Arguments: Recent bond volatility reflects a reassessment of U.S. growth, inflation, and Fed policy rather than a purely technical move. The market has also repriced a higher term premium because large sovereign deficits and issuance are harder to absorb when inflation is sticky and policy is uncertain. U.S. macro data has stayed resilient, especially the labor market, reducing confidence in aggressive Fed easing. Markets may be overestimating the long-run neutral rate and the inflation impact of tariffs. The market appears to be pricing worst-case outcomes for tariffs, labor costs, and fiscal imbalances, which has amplified volatility. In Europe and the UK, higher yields are more of a spillover from U.S. rates than a reflection of stronger domestic fundamentals. Corporate borrowers can still function in the higher-rate environment because earnings are generally offsetting higher interest expense. Second-round inflation effects from tariffs are likely to remain limited unless policy shocks feed into wages and expectations. A gradual cutting cycle and softer underlying inflation should help bond markets stabilize over time.

Data Points: U.S. 10-year yield increase: about 100 basis points higher - George describes the rise in U.S. 10-year Treasury yields since around September UK 10-year yield increase: about 100 basis points higher - George says UK yields moved similarly to U.S. yields over the same period European yield increase: about half the U.S. move - George says European yields rose by roughly 50 bps over the period Expected Fed cuts before payrolls: just over one cut for the remainder of 2025 - Johnny describes market pricing before the payrolls report Probability of higher short-term rates: 35% over the next 12 months - Johnny says markets briefly priced a meaningful chance the Fed could hike 10-year Treasury term premium: around 60 basis points - Johnny says this is the highest level in over 10 years, or at least since 2015 Neutral rate market assumption: around 3% previously, possibly nearer 4% in market pricing - Johnny explains the market’s reassessment of the neutral rate of interest Fed inflation target: 2% - Referenced as the benchmark toward which inflation is expected to move more slowly Forecast U.S. 10-year yield: 4.35% - George’s 2025 year-end forecast Forecast UK gilt yield: 4% - George’s 2025 year-end forecast Forecast European yield: 1.9% - George’s 2025 year-end forecast Recording date: Friday, January 17th, 2025 - Episode timestamp

Pivotal Quotes: "we know that deficits are large, there is a lot of supply of sovereign bonds coming to market." — George Cole: Explaining why investors are demanding a higher term premium "the market is pricing some of these outcomes to worst." — Johnny Fine: Describing how uncertainty around tariffs, labor costs, and fiscal policy has pushed yields higher "I think that the market's fear that the neutral rate of interest is higher than anyone thought it was 12 months ago. I think that's overblown." — Johnny Fine: Johnny's bullish view on bonds and skepticism about the repricing of the neutral rate

Implications: Bond markets may stay volatile until inflation and policy uncertainty clear, but if underlying inflation cools and tariff second-round effects stay contained, yields could ease in 2025. Investors may continue to favor credit, while issuers may lock in shorter-duration financing.