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Readers will likely have heard that foreign investors are wary of US assets, including Treasuries. There is something in this, but it’s not necessarily new. Foreign demand for Treasuries has been fading for nearly two decades. In 2008, foreign investors owned nearly 60% of outstanding US Treasuries. Today they hold a little over a third. US banks and households have filled the gap, and both tend to prefer shorter-dated bonds. The US pension system holds fewer government bonds than many others, so there is less natural domestic demand for long-dated debt. That adds some upward pressure on long-dated yields, but it’s far from a crisis. These forces build slowly and matter most at the long end. They have not driven the past year’s move, but they are why we think yields have further to go.
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Overall, our bias is for yields to move gradually higher. We don’t think they have peaked.
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The case for inflation, and why we don’t buy it yet
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Inflation in 2026 is clearly higher than many of us expected at the start of the year. The Middle East conflict and the energy shock that followed are pushing prices up. But this is a supply shock, not a demand shock. If inflation expectations stay in check, any rate hikes should be modest. Importantly, the Fed’s first rate hike under its new chair has earned it some credibility. Markets appear to believe that the Fed and other central banks are serious about tackling inflation.
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Underlying inflation pressure is more visible in the US, but weaker than in late 2021 and early 2022. In the UK, we see fewer signs of second-round effects taking hold, and services inflation keeps trending lower. The European Central Bank, whose single mandate is price stability, has reacted earlier to higher energy prices than the Fed or the Bank of England.
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Higher rates aren’t felt equally
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Higher rates hurt borrowers and help savers. After years of cutting debt since the Global Financial Crisis, households and companies in much of the world are far less sensitive to rates than before. Many now see their interest income rise faster than their interest costs. In aggregate, UK households now receive more interest than they pay.
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The flip side is that governments have borrowed more. Government debt in many developed countries is at multi-decade highs. But what matters for public finances is not the level of yields but how they compare with growth.
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If nominal growth runs above the average interest rate a government pays, the debt burden can hold steady even with a modest deficit. If borrowing costs overtake growth, the burden snowballs. Two things matter here. First, the average cost of debt lags market yields, because only debt being refinanced resets at today’s rates. That’s why refinancing walls matter.
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Second, the real damage comes when growth slows while yields stay high. On this measure, the US is in better shape than the headlines suggest. US debt of $40 trillion sounds scary, but nominal growth is still above borrowing costs.
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In the US, about a third of publicly held marketable debt matures in the next 12 months, and bills alone make up more than a fifth. Yet the average interest rate on US government marketable debt was 3.475% in August, up just 0.06 percentage points on a year earlier and more than 1.5 percentage points below the 10-year yield. Even so, the cost is already showing. Net interest passed $1 trillion in the first 11 months of the fiscal year, about 9% more than a year earlier, and the Congressional Budget Office expects it to take about 14% of federal spending this year1. That’s not a crisis. But each year that yields stay above the average cost of debt, that average creeps higher and the margin for error shrinks.
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In France, the picture is less reassuring. France’s problem is not how fast higher yields feed through; it is growth. Its negotiable debt has an average maturity of about 8.5 years, and bills are less than a tenth of the total, so higher yields feed through more slowly than in the US. Real GDP was flat in the second quarter after falling in the first, and was just 0.7% higher than a year earlier. Even with inflation at 2.4%, nominal growth is only about 3%. That’s below the 3.5% average yield on bonds issued this year, and well below the 10-year yield of about 4.8%, its highest since 20081. At the margin, France is borrowing at a higher rate than it is growing. That explains why yields and the term premium have risen so much there.
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The UK is in better shape. Growth is decent, though slower than in the US, and its debt has a longer maturity than US or French debt, which slows the pass-through of higher yields to interest costs. We think fears about UK public finances are overdone, which makes gilts look a little more attractive to us today.
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In credit markets, not every company locked in cheap debt when it could, and at the riskiest end of the market that is starting to show. US CCC-rated spreads are now 0.5 percentage points above their long-run average of 11%1, after a poor September added 1 percentage point. Some issuers are businesses disrupted by AI, but many simply face higher refinancing rates. Higher-quality companies are a different story: investment-grade spreads have held steady. We see this as a canary, not a crisis. It is not the end of the cycle, but it is later than we’d like. If oil and yields hold at these levels, the pressure could spread.
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What does this mean for investors?
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For bonds, rising yields mean price losses. But starting yields are now high enough that income cushions much of the damage. Bonds are behaving like bonds again.
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This is illustrated by the chart below. If 10-year bond yields in the US, UK and France increase by 0.5 percentage points in the next year from their current levels, investors would still have a small, positive return for the year. A 0.5 percentage point rise in 10-year Bunds or Japanese government bonds (JGBs) would leave investors underwater.
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Structural forces: Large fiscal deficits and more borrowing by the AI hyperscalers mean more bonds for markets to absorb. When people talk about ‘crowding out’, they mean buyers may choose corporate debt over government debt. More supply means lower prices and higher yields.
Readers will likely have heard that foreign investors are wary of US assets, including Treasuries. There is something in this, but it’s not necessarily new. Foreign demand for Treasuries has been fading for nearly two decades. In 2008, foreign investors owned nearly 60% of outstanding US Treasuries. Today they hold a little over a third. US banks and households have filled the gap, and both tend to prefer shorter-dated bonds. The US pension system holds fewer government bonds than many others, so there is less natural domestic demand for long-dated debt. That adds some upward pressure on long-dated yields, but it’s far from a crisis. These forces build slowly and matter most at the long end. They have not driven the past year’s move, but they are why we think yields have further to go.
Overall, our bias is for yields to move gradually higher. We don’t think they have peaked.
The case for inflation, and why we don’t buy it yet
Inflation in 2026 is clearly higher than many of us expected at the start of the year. The Middle East conflict and the energy shock that followed are pushing prices up. But this is a supply shock, not a demand shock. If inflation expectations stay in check, any rate hikes should be modest. Importantly, the Fed’s first rate hike under its new chair has earned it some credibility. Markets appear to believe that the Fed and other central banks are serious about tackling inflation.
Underlying inflation pressure is more visible in the US, but weaker than in late 2021 and early 2022. In the UK, we see fewer signs of second-round effects taking hold, and services inflation keeps trending lower. The European Central Bank, whose single mandate is price stability, has reacted earlier to higher energy prices than the Fed or the Bank of England.
Higher rates aren’t felt equally
Higher rates hurt borrowers and help savers. After years of cutting debt since the Global Financial Crisis, households and companies in much of the world are far less sensitive to rates than before. Many now see their interest income rise faster than their interest costs. In aggregate, UK households now receive more interest than they pay.
The flip side is that governments have borrowed more. Government debt in many developed countries is at multi-decade highs. But what matters for public finances is not the level of yields but how they compare with growth.
If nominal growth runs above the average interest rate a government pays, the debt burden can hold steady even with a modest deficit. If borrowing costs overtake growth, the burden snowballs. Two things matter here. First, the average cost of debt lags market yields, because only debt being refinanced resets at today’s rates. That’s why refinancing walls matter.
Second, the real damage comes when growth slows while yields stay high. On this measure, the US is in better shape than the headlines suggest. US debt of $40 trillion sounds scary, but nominal growth is still above borrowing costs.
In the US, about a third of publicly held marketable debt matures in the next 12 months, and bills alone make up more than a fifth. Yet the average interest rate on US government marketable debt was 3.475% in August, up just 0.06 percentage points on a year earlier and more than 1.5 percentage points below the 10-year yield. Even so, the cost is already showing. Net interest passed $1 trillion in the first 11 months of the fiscal year, about 9% more than a year earlier, and the Congressional Budget Office expects it to take about 14% of federal spending this year1. That’s not a crisis. But each year that yields stay above the average cost of debt, that average creeps higher and the margin for error shrinks.
In France, the picture is less reassuring. France’s problem is not how fast higher yields feed through; it is growth. Its negotiable debt has an average maturity of about 8.5 years, and bills are less than a tenth of the total, so higher yields feed through more slowly than in the US. Real GDP was flat in the second quarter after falling in the first, and was just 0.7% higher than a year earlier. Even with inflation at 2.4%, nominal growth is only about 3%. That’s below the 3.5% average yield on bonds issued this year, and well below the 10-year yield of about 4.8%, its highest since 20081. At the margin, France is borrowing at a higher rate than it is growing. That explains why yields and the term premium have risen so much there.
The UK is in better shape. Growth is decent, though slower than in the US, and its debt has a longer maturity than US or French debt, which slows the pass-through of higher yields to interest costs. We think fears about UK public finances are overdone, which makes gilts look a little more attractive to us today.
In credit markets, not every company locked in cheap debt when it could, and at the riskiest end of the market that is starting to show. US CCC-rated spreads are now 0.5 percentage points above their long-run average of 11%1, after a poor September added 1 percentage point. Some issuers are businesses disrupted by AI, but many simply face higher refinancing rates. Higher-quality companies are a different story: investment-grade spreads have held steady. We see this as a canary, not a crisis. It is not the end of the cycle, but it is later than we’d like. If oil and yields hold at these levels, the pressure could spread.
What does this mean for investors?
For bonds, rising yields mean price losses. But starting yields are now high enough that income cushions much of the damage. Bonds are behaving like bonds again.
This is illustrated by the chart below. If 10-year bond yields in the US, UK and France increase by 0.5 percentage points in the next year from their current levels, investors would still have a small, positive return for the year. A 0.5 percentage point rise in 10-year Bunds or Japanese government bonds (JGBs) would leave investors underwater.
