Bond yields are falling this morning, easing fears of a sovereign debt crunch for some of the world’s most indebted nations. The drop in bond yields is most pronounced in Japan, the 30-year yield is down 20bps, the 30-year US Treasury yield is lower by 7bps and yields in Europe are also lower, led by the UK. The driver of the bond market move was reports that Japan’s finance ministry has tapped bond investors to ask their opinions about the appropriate amount of debt issuance they can absorb.
Japan takes action to placate bond investors, will others follow suit?
This suggests that officials in Japan will reduce debt issuance after a disappointing auction last week saw Japanese bond yields surge, which added pressure to other western yields. If the government is going to offer less debt for sale to the broader market this leaves two options for Japan’s government: a massive cut its debt levels, which are more 200% of GDP, or push the Bank of Japan to slow down the pace it is shrinking its balance sheet, which could derail its plan to ‘normalize’ monetary policy. The latter seems like the most likely option, to us.
The yen declines
The decline in Japanese yields, along with the prospect of a les hawkish BOJ has weighed on the yen, which is the weakest performer in the G10 FX space on Tuesday. The Swiss franc is also under pressure as risk sentiment rises. However, the dollar has not made much headway after falling sharply last week.
Debt levels still a concern
Last week’s decline in the dollar was worrying because of the surge in bond yields. The key concern in the bond market was the US, and its rising debt levels under President Trump, however, western yields were mostly rising in unison, as highly indebted nations run out of road to fund their ever-increasing deficits.
Going forward, perhaps other indebted nations like the UK or the US should also ask the market about their appetite for debt issuance. This could then feed directly into budget discussions, rather than have a never-ending political back and forth about budget cuts, that are then rolled back, and trying to scrimp together tax revenue to cover ever higher levels of spending.
Stabilizing bond yields boosts sentiment
The US Budget Bill, which also weighed on US Treasury yields last week, is currently with the Senate, which could have a moderating influence on the size of the deficit. This may acquiesce bond investors, and reflect well on equity markets, which were unsettled by the jump in long end bond yields last week, especially in the US, Japan and the UK. The decline in yields means that the US 30-year yield is back below 5%. This is a psychologically important level: yields jump above it and risk sentiment fades, yields fall below it, and risk sentiment is given a boost.
UK: FTSE 100 remains well protected, as domestic equities suffer from bond market risk
Going forward, the bond market could be a big driver of stocks. Ironically enough, considering the UK bond yield was rising sharply last week, this did not weigh on the FTSE 100, and it was one of the best performing European indices last week. However, the real pain of higher yields is felt in the more domestically focused indices, the FTSE 250 slid by more than 1% last week, and we could see more under performance if bond yields remain unstable going forward.
‘TACO’ Trump likely to roll back on EU tariffs
European stocks are lower this morning, although UK stocks are surging and US stock index futures are also pointing to a higher open, after US stocks sold off sharply last week. News that a threatened 50% tariff rate on EU imports to the US would be delayed until July, after President Trump initially said the 50% rate would come into force on June 1st, has also boosted European stocks on Monday, but that recovery rally has now run out of steam, as the market waits for news on progress between the EU and US trade talks. Donald Trump has rolled back so many times on tariffs, that the message does not hold as much weight these days. Of course, the EU will face tariffs and there could be big changes ahead, but a 50% tariff is expected to be whittled down, after Trump rowed back on excessive tariff rates with China. This is why the decline in European stocks on Friday was fairly moderate.
French CPI adds fuel to bond market rally
The euro is also in the spotlight on Tuesday, after a weaker than expected reading for May CPI in France. EUR/USD has backed away from $1.14 after French inflation fell 0.1% this month, pushing the annual rate down to a mere 0.6%. This is adding fuel to the global bond market rally. There is a near 100% chance of a rate cut from the ECB priced in by the interest rate futures market, with a further 1.4 cuts priced in for the second half of 2025 after the June cut.
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