Sum of all fears

THE recent hike in global Treasury yields has led investors to reassess the equity market’s attractiveness.

With the 10-year US Treasury yield hitting a high of 5.34% – the highest since April 2002 – the yields on other major sovereigns have also risen to levels not seen in years.

The Japanese 10-year Treasury is now running above 3.1%, while both Australia’s and the United Kingdom’s similar-tenure papers are well above the five-handle and were last seen at 5.4%.

Alarm bells?

While inflation is elevated and seems sticky, current global sovereign yields reflect more than just the inflation story.

A confluence of factors drives them, and when they align in a certain direction, the bond market will react by pricing in the added market risk.

As it is, the US Treasury curve is flattening: the spread between the 10-year and two-year, which recently narrowed to just 17 basis points (bps), is now at 48 bps.

Should the spread between the 10-year and two-year turn negative, the yield curve inversion would be the first sign of an impending recession within the next year or so. The rise in shorter-tenor yields also signals that investors expect further rate hikes.

Based on current Fed Funds futures, the market now expects the US Fed Funds Rate (FFR) to rise one more time this year to 4% to 4.25% and then undergo two more hikes in 2027, bringing the FFR to 4.5% to 4.75%.

With the market expecting three rate hikes over the next 12 months, the underlying story driving the forecast is more than just elevated inflation. What are these factors?

Elevated debt

It is not just about the United States having uncontrollable federal government debt, which has passed the US$40 trillion mark; it is a global phenomenon.

Based on the latest data from the Institute of International Finance (IIF), global debt has reached US$365 trillion as at the first half of 2026 (1H26), and the debt-to-gross domestic product ratio was last seen at 3.1 times.

With most nations running budget deficits and debt servicing increasingly becoming a key expense, investors in sovereign papers are demanding higher returns on new debt papers.

IIF data also shows that advanced economies paid more in interest on government bonds than they spent on defence, artificial intelligence (AI), or even clean energy.

Investors are also cautious about the avalanche of off-balance-sheet debt being raised by some big-name hyperscalers, which has now surpassed US$3.6 trillion in total.

With more debt supply in the market, investors will naturally demand higher returns.

Not working

To ease pressure from rising bond yields, the US Treasury announced a bond buyback programme to conduct a yield-control exercise.

However, because the US bond market is the most heavily traded globally, the market can easily absorb any buyback programme.

The US Treasury also tried to influence the Japanese yen recently as the currency fell to a fresh 40-year low, and it did so by selling euros to buy the yen.

Although this had some effect on the market, the impact remains minimal, as Japan has other problems to worry about, mainly rising inflationary pressures.

Even the Bank of Japan (BoJ) had no choice but to listen to the market, as it too raised rates by 25 bps to 1.25%. Measures by the BoJ, the US Federal Reserve, or any other central banks seem ineffective, as other factors are playing out and have a greater impact on the bond market than inflation expectations alone.

Oil and geopolitics

The never-ending war in Iran has caused a severe impact on oil prices as well as geopolitical tensions in the Middle East. With oil prices back above the US$100/barrel mark, inflationary pressure from higher fuel prices will remain elevated for at least another six months or longer.

Thereafter, the impact will be reduced unless oil prices move even higher, as the base effect will reduce year-on-year inflation prints.

Trump and rates

Since taking office in 2024, US President Donald Trump’s foreign policy on trade, tariffs and war has had the biggest impact on financial markets. This is unlikely to change, even if he loses the US mid-term elections next month.

Trump is adamant about having it his way, and he does not care about international law or conventions.

His “war” against the rest of the world will continue, especially over tariffs, which will likely keep interest rates elevated due to inflationary impact.

Trump’s military spending will keep the United States in deep budget deficits, increasing debt-funding requirements.

If this persists, investors will demand higher rates as the US debt profile has become a significant worry for central banks.

Major global central banks have already raised rates, and markets still expect rates to stay higher through the rest of 2026 and into 2027.

Rising tide lifts all boats, and in the case of inflation, rising inflation will lift rates across the globe.

This also means the spread between US Treasuries and the rest of the world is unlikely to change much, as most central banks are expected to raise rates.

This is now supporting the dollar, which is now up by 4% year-to-date.

The big rotation

With global interest rates rising, the lure of equity and dividend-yielding stocks will be impacted as investors find parking money in, let’s say, the 10-year US Treasury yielding 5.3% good enough and equivalent to stocks that are trading at a price-to-earnings (PE) multiple of 19 times.

Stocks are only attractive if earnings growth exceeds 19%, as investors would be unwilling to pay a higher market price for stocks with slower growth momentum.

Interestingly, based on consensus estimates, the S&P 500 Index is trading right at 19 times forward PE multiple, which suggests the US equity market remains attractive.

Still, the challenge may be finding market gems that grow faster than the rest, especially within the current market theme in the technology sector and AI-related stocks.

In conclusion, rising bond yields, not just in the United States but globally, can be a significant event risk for financial markets, and it is really a reflection of the sum of ALL fears when it comes to factors that impact investors’ sentiment and cautious views.

However, as of now, with the S&P 500 and Nasdaq 100 hitting fresh all-time highs, US$100/barrel oil, the 5.3% 10-year US Treasury yield and, of course, the stronger dollar, the equity market has not been hit just yet.

In other words, the market is still “relatively comfortable” with higher bond yields, but the breaking point may be approaching if yields keep climbing.