Investors tend to fixate on the stock market, but there are times when the bond market cries out for our attention, too.
That’s definitely the case today, because it’s sending out distress signals. The global bond market is actually the bigger of the two, worth about $140 trillion, compared with $115 trillion for equities.
And when bond yields surge, the ripple effects can shape everything from mortgage rates to stock valuations and government solvency.
In recent weeks, yields on long-dated US government bonds, or Treasuries, have jumped to their highest levels since the global financial crisis. Investors are demanding more interest to lend to governments awash with debt, at a time when sticky inflation deters central bankers from slashing interest rates.
Tom Stevenson, investment director at Fidelity International, said the US 30-year Treasury yield climbed above 5 per cent in May as markets recoiled at US President Donald Trump’s new tax cut proposals, known as the “Big, Beautiful Bill”.
That package alone could add more than $3 trillion to US debt, which already stands at a mountainous $36 trillion. It could lift the country’s debt-to-GDP ratio from about 100 per cent today to 125 per cent within a decade.
“The prospect of higher borrowing and unsustainable debt servicing costs led Moody’s to downgrade the US prized triple-A credit rating. Debt interest payments, already at $880 billion a year, will rise further as a result,” Mr Stevenson says.
He sees trouble ahead. “The US has lived beyond its means thanks to strong global demand for its debt. But confidence is beginning to wane, with investors seeking to diversify elsewhere.”
Vijay Valecha, chief investment officer at Century Financial in Dubai, says a similar story is unfolding elsewhere. In Japan, 30-year yields have climbed towards 3 per cent following the weakest demand in a decade. In the UK, 30-year gilt yields briefly touched 5.55 per cent as government borrowing soared.
Yet at the same time, stock markets have rallied after Mr Trump paused his “liberation day” trade tariffs on April 9, Mr Valecha says. “US markets enjoyed a V-shaped recovery with the S&P 500 up almost 20 per cent, while the tech-focused Nasdaq rose 27 per cent.”
The UK’s FTSE 100 and Japan’s Nikkei 225 are both trading above key technical levels, he adds.
But investors shouldn’t assume this will continue. “Global government debt is rising fast, pushing 95 per cent of GDP," he says. "If this continues, debt could reach 100 per cent of GDP by the end of the decade.”
Global inflation is also proving sticky, driving up interest rates and yields. That’s a warning shot for stock markets.
Mr Valecha flags up something called the “equity risk premium”, which measures the difference between what investors can expect from shares and the yield from lower-risk bonds. “As bond yields rise that gap gets smaller, it becomes harder to justify paying high prices for shares, especially when valuations are already stretched.”
The equity rally may continue but it will be bumpier, and careful stock picking is required, Mr Valecha says.
Near-zero interest rates
Near-zero interest rates allowed governments to borrow freely in the past decade, but that era is now over, says Charu Chanana, chief investment strategist at Saxo Bank. “Rising sovereign debt is arguably one of the most underappreciated long-term risks to global financial stability.”
If interest rates remain elevated, this could crowd out public investment, put pressure on social spending and, ultimately, reduce economic dynamism, she says.
High debt levels also suppress growth, which fuels more borrowing in a vicious cycle. “The fiscal space to respond to future crises is being eroded,” Ms Chanana says.
The risk is amplified in emerging markets, many of which have borrowed heavily in US dollars, making debt harder to service if their currencies weaken.
Corporate earnings remain resilient but the equity rally may have run its course, she says. “Further equity upside may require either stronger earnings growth or a clearer path towards monetary easing.”
While cash and bonds offer short-term comfort, don’t overdo the flight to safety. Ms Chanana warns that higher inflation will chip away at the real return. “Increased exposure to cash or bonds may not be sufficient to preserve or grow wealth over the long term.”
Instead, she favours a diversified approach. “Equities, particularly those tied to structural themes like AI and digital infrastructure, continue to offer compelling growth opportunities.”
While gold has stood bright as a hedge against inflation and economic and political volatility, it also has one big drawback as yields rise – it doesn’t pay interest or dividends.
Higher yields increase the opportunity cost of holding gold, but that hasn't deterred investors yet, with the price up 26 per cent this year. “Gold still plays a strategic role as a hedge against systemic risk, currency debasement and geopolitical uncertainty,” Ms Chanana says.
Should investors turn back to bonds?
Tony Hallside, chief executive of Dubai-based brokers STP Partners, agrees that gold still has a role to play in a diversified portfolio but suggests rebalancing towards high-quality fixed income. “Investment-grade bonds, especially with shorter durations, provide attractive yields while preserving capital. They offer stability and liquidity when markets turn turbulent."
“That doesn’t mean abandon stocks entirely, but it does mean being more selective."
Amol Shitole, head of fixed income at Mashreq Capital, sees an opportunity in emerging market bonds, particularly in the Middle East and North Africa. Mena bonds continue to enjoy haven status due to their superior credit quality, he says. “We favour the UAE, Qatar, Oman and Morocco for their strong fundamentals and ongoing structural reforms.”
He says Mashreq remains underweight on Saudi Arabia and Bahrain, citing fiscal risks and tight valuations.
He doesn’t expect US yields to spiral uncontrollably. “We believe US Treasuries will continue to benefit from flight-to-safety demand during slowdowns or uncertainty.”
In equities, he sees opportunities in small caps and value stocks, particularly as higher interest rates pressure growth sectors. “A well-diversified multi-asset portfolio including equities, fixed income, gold and alternatives can yield attractive returns of 7 per cent to 7.5 per cent a year.”
There is little prospect of a return to ultra-low interest rates, but at least this means bond investors are being rewarded gain.
Equity investors must be more careful, but strong companies still offer solid long-term value. Gold remains a valid hedge. As ever, diversification is the best defence.
Investors don’t need to panic. But if yields keep rising, they will need to adapt.
