In this month’s commentary our Chief Economist, Colin Warren, looks at a range of factors – including increased debt issuance and fewer price-insensitive buyers – that are keeping long-term bond yields high, and what this might mean for investors.
Over the past year or so, central banks across most developed economies have been cutting interest rates. However, long-term government bond yields remain stubbornly elevated, hovering near their highest levels in over a decade. In this month’s article, we explore the reasons behind this apparent disconnect and consider what it means for investors.
Historically high yields
Over the last year, major central banks such as the US Federal Reserve, the European Central Bank (ECB) and the Bank of England have cut policy interest rates, as inflation has fallen back following the spike seen in the wake of the pandemic. This has resulted in short-term borrowing costs coming down.
However, the yields on long-term bonds have remained stubbornly high. By way of example, the yield on the 30-year US Treasury bond currently trades around 4.9%, close to the 18-year high of 5.1% seen in May1. The UK 30-year Gilt currently yields around 5.25%, close to highs not seen since 19982.
While short-term bond yields are closely tied to central bank policy rates and their expected future path, long-term yields are also shaped by a broader set of influences, including inflation expectations, the fiscal outlook, and supply-demand dynamics in the bond market.
At the current juncture, investors are demanding a higher yield on long-term government debt for a range of reasons.
Rising debt
A key factor is the sheer scale of outstanding government debt globally, coupled with expectations of further increases in bond issuance. In the United States, President Trump’s tax-cutting 'Big Beautiful Bill' - approved by the House of Representatives and now being debated in the Senate - is projected to keep budget deficits elevated and drive a substantial rise in debt issuance over the coming years. According to the Committee for a Responsible Federal Budget (CRFB), the bill will increase US public debt by US$3.0 trillion, raising the debt to GDP ratio from 100% today to 124% of GDP by 2034. The bill is also expected to double debt servicing costs between 2024 and 2034, to US$1.8trillion (4.2% of GDP)3.
In May, Moody’s became the last major agency to strip the US of its top AAA credit rating, downgrading it to AA1, noting that successive US governments had failed to reverse rising budget deficits and debt servicing costs4. Although the ability of the US government to pay its debts is not in doubt, investors are demanding a higher yield to hold it.
European defence spending
In Europe, heightened geopolitical risks and the prospect of reduced US military support from the Trump administration are forcing governments to increase spending on defence. The German government’s recent relaxation of its debt rules, in order to spend more on defence and infrastructure (see our commentary of March 2025) will lead to increased debt issuance, with some estimates suggesting it could increase by more than one trillion euros over the next 10 years5.
EU NATO members currently allocate around 2% of GDP to defence6, but President Trump has urged allies to raise this to 5% - a proposal that has received support from NATO Secretary General Mark Rutte7. Even if this target is not fully realised, a significant increase in defence spending, combined with the fiscal pressures of ageing populations and rising investment in the green transition, is likely to lead to higher levels of government debt issuance across Europe.
From QE to QT
These increased demands on public spending are coming at a time when there are fewer price insensitive buyers in the global bond market. Having implemented large-scale bond purchases through quantitative easing (QE) programmes during the global financial crisis and again during the pandemic, several major central banks have, in recent years, begun unwinding these positions, engaging in so-called quantitative tightening (QT) by reducing their holdings of government bonds.
The Fed’s holdings of US Treasuries, currently around US$4.2 trillion, have fallen by around US$1.56 trillion since 2022, as the US central bank has let maturing bonds roll off its balance sheet without reinvesting the proceeds8. Here in the UK, the Bank of England’s Asset Purchase Facility currently holds £620 billion of UK Gilts, around £255 billion less than in 2022, as the monetary authorities have allowed bonds to mature and also undertaken active gilt sales as part of their quantitative tightening strategy9.
Japan, where public debt stands at approximately 235% of GDP10, has also played a significant role in shaping recent developments. The Bank of Japan (BoJ) halted its policy of yield curve control (YCC) in March 2024 and has since nudged interest rates higher as inflation has picked up11. The BoJ recently reported that its holdings of long-term Japanese government bonds (JGBs) fell for the first time since 200812.
Pension fund demand
There are also indications that demand for long-term government bonds from pension funds has also waned13, 14. Pension funds have historically been major buyers of long-term government bonds because these assets closely match the long-duration liabilities of defined benefit pension schemes. Holding long-dated bonds help hedge interest rate risk and ensure predictable cash flows to meet future retiree payments. However, this dynamic has shifted. Defined benefit schemes are now less common. Moreover, many pension schemes are now better funded due to a combination of higher interest rates (which have reduced the present value of future liabilities) and strong asset performance in recent years. As a result, pension funds have not needed to buy as much long-dated government paper.
Inflation uncertainty
With the prospect of increased issuance coming to market, and less demand from price insensitive buyers, long-term yields have had to rise to attract more value-conscious investors. Heightened policy uncertainty - and the associated risk of more volatile macroeconomic outcomes, such as unexpectedly high inflation - means investors are likely to demand a greater risk premium for holding long-term debt.
There is little doubt that President Trump’s unpredictable trade policies have contributed to elevated levels of policy uncertainty. Furthermore, key elements of his broader agenda—such as isolationism (which reduces competition), curbs on immigration, and unfunded fiscal expansion—pose clear risks of fuelling upward pressure on inflation over the long term. President Trump’s recent criticism of the Federal Reserve15, combined with the upcoming expiry of Fed Chair Jerome Powell’s term in May 2026, raises concerns that monetary policy could become increasingly politicised, potentially undermining market confidence in the Fed’s commitment to maintaining price stability. These factors have likely played a role in exerting upward pressure on long-term U.S. Treasury yields.
Implications for investors
Investors who purchased long-term government bonds at the historically low yields seen during the pandemic have since faced substantial mark-to-market losses as yields have risen, reflecting the inverse relationship between bond yields and prices.
However, new investors purchasing at current levels can lock in relatively high yields. The real (i.e. after inflation) yield on the 30-yr US Treasury Inflation Protected Security is currently around 2.7%16. This said, investors should be mindful that so-called ‘long-duration’ bonds are highly sensitive to changes in interest rates and yields; any further rise in yields could result in significant mark-to-market losses.
Elevated government bond yields have implications for other asset classes. High long-term yields on relatively safe government bonds tend to diminish the relative attractiveness of riskier equity investments. If an investor can obtain a 5% yield on a government bond, there might be less incentive to invest in riskier equity markets. One widely used measure of relative valuation for U.S. equities - the equity risk premium (defined as the earnings yield minus the yield on the 10-year U.S. Treasury) - indicates that the main U.S. equity index is currently trading at its most expensive level relative to bonds in more than two decades17.
In addition, high long-term government bond yields reduce the present value of future profits. Government bond yields are often used as the discount rate in equity valuation because they represent the return investors can earn on a virtually risk-free, long-term investment. The higher this risk-free return, the less valuable future company profits are today. This effect is especially pronounced for fast-growing companies, whose valuations depend heavily on profits expected many years from now. When those distant earnings are discounted at a higher rate, their current value drops sharply, potentially leading to pressure on equity valuations.
Higher long-term government yields are also likely to translate into increased financing costs for the private sector. In the US, where 30-year fixed-rate mortgages are common, elevated long-term rates will keep new mortgage rates high, potentially weighing on housing market activity. Similarly, higher government bond yields will keep corporate bond yields elevated, raising borrowing costs for businesses and potentially constraining profitability and investment.
The long end matters
With global equity markets trading near record highs, investors have so far shrugged off the potential adverse implications of high long-term government bond yields. However, policymakers are increasingly alert to the associated economic and financial risks, and are beginning to take steps to contain upward pressure on long rates. In the US, UK, and Japan, the authorities are seeking to adjust the composition of sovereign debt issuance by shifting from long-term bonds towards shorter-dated instruments, in a bid to take some of the pressure off long rates18,19. US Treasury Secretary Scott Bessent has also signalled that regulatory reforms may be introduced to incentivise banks to increase their holdings of US Treasuries20 - an initiative that could help to anchor yields.
Nevertheless, in the absence of credible fiscal consolidation aimed at restoring the long-term sustainability of public finances, the forces pushing long-term borrowing costs higher are unlikely to abate. Although central bank policy rate decisions will remain a focal point for markets, investors should also pay close attention to developments at the long end of the yield curve.
16 June 2025
1 https://www.cnbc.com/quotes/US30Y
2 https://www.cnbc.com/quotes/UK30Y-GB
3 https://www.crfb.org/blogs/cbo-estimates-3-trillion-debt-house-passed-obbba
4 https://www.bbc.co.uk/news/articles/c4ge0xk4ld1o
8 https://fred.stlouisfed.org/series/TREAST
11 https://tradingeconomics.com/japan/interest-rate
12 https://kfgo.com/2025/05/28/boj-long-term-government-bond-holdings-fall-for-first-time-since-2008
13 https://pensionsage.com/pa/Bonds-falling-out-avour-with-pensions.php
14 https://www.wsj.com/finance/investing/pension-funds-wont-save-the-bond-market-1fed3c2c
15 https://www.cnbc.com/2025/06/12/trump-powell-numbskull-fed-rates.html
16 https://www.cnbc.com/quotes/US30YTIP
18 https://www.ft.com/content/106117dc-5294-4cf8-9f47-7fc8d8805dfd
19 https://www.ft.com/content/106117dc-5294-4cf8-9f47-7fc8d8805dfd