Global Bond Selloff: Why Yields Are Surging and Why Investors Shouldn’t Abandon Bonds

Global bond markets are facing one of their sharpest repricings in years. The selloff accelerated on Tuesday, September 1, and extended into Wednesday as investors confronted a combination of renewed inflation risks, higher oil prices, deteriorating fiscal positions and expectations that central banks may have to keep monetary policy tighter for longer.The scale of the move is striking. The U.S. 10-year Treasury yield climbed to around 4.81%, close to a three-year high, with a move toward 5% increasingly viewed as possible. Japan's 10-year government bond yield moved above 3%, its highest level in 30 years, while Australia's 10-year yield reached 5.198%, a more than 15-year high. In Europe, German Bund futures fell to their lowest level since 2011 and French OAT futures also hit record lows. Meanwhile, the UK's 30-year gilt yield reached levels not seen since 1998.For investors who have spent the past few years favouring equities, higher yields could gradually make bonds more attractive again, while their diversification role becomes increasingly valuable if the equity market eventually loses momentum.Oil has reignited the inflation problemThe immediate catalyst for the latest move was another jump in energy prices as fighting resumed between the U.S. and Iran around the Strait of Hormuz.WTI crude surged more than 5% to above $90 a barrel, while Brent rose more than 4% to above $94. The renewed disruption comes after oil had fallen below $70 earlier in the summer, meaning the reversal has been particularly rapid.For bond investors, the problem is not simply that oil is more expensive. Energy prices can feed into transportation, manufacturing, food and household costs, potentially creating a second wave of inflation. That matters because the market had increasingly hoped that inflation would continue moderating sufficiently to allow central banks to leave rates unchanged or reduce interest rates.The latest geopolitical shock challenges that assumption.Eurozone inflation, for example, accelerated to 3.3% in August, according to preliminary data, with energy inflation particularly elevated. At the same time, Brent crude has moved back toward $96 a barrel.This creates a difficult environment for government bonds. Investors buying a 10-year bond today need to be compensated not only for the time value of money but also for the risk that inflation will erode the real value of future coupon payments. As inflation expectations rise, investors generally demand higher yields.The result is a vicious circle: higher energy prices increase inflation expectations, which push yields higher, which increase borrowing costs across the economy.Fiscal concerns are becoming impossible for bond markets to ignoreThe oil shock is only the latest trigger. Underneath the selloff is a much more structural problem: governments are carrying historically large amounts of debt while borrowing costs are no longer close to zero.The U.S. national debt was already approaching $40 trillion in July, having risen by more than $3 trillion over the previous year. Across developed economies, investors are increasingly questioning how governments will finance persistent deficits without either significantly stronger economic growth, spending cuts or higher taxes.Japan is an especially important example. Its 10-year yield has risen to levels last seen in the 1990s as investors reassess both inflation and the country's fiscal outlook. Rising debt-servicing costs could constrain the government's ability to pursue further fiscal expansion.The same issue is visible in Europe and the UK. Britain's public-sector net debt reached almost 95% of GDP by June 2026, while debt-servicing costs remain historically elevated. France is also facing increased scrutiny because of its persistent budget deficit and political uncertainty.This creates what investors sometimes describe as a fiscal risk premium. If governments need to issue increasingly large quantities of debt, investors may demand higher yields to absorb that supply.And once yields rise, refinancing becomes more expensive, potentially requiring even more borrowing. That is the debt dynamic increasingly worrying bond investors.Central banks may not be able to rescue the bond marketFor much of the post-financial-crisis period, investors could rely on central banks to support government bond markets whenever economic conditions deteriorated.That assumption is much less secure today.The latest inflation shock is particularly uncomfortable because it comes at a time when central banks are already questioning whether inflation has been brought fully under control. Federal Reserve Chair Kevin Warsh's recent comments have revived expectations of a September rate increase, with markets also pricing greater chances of additional tightening elsewhere.The U.S. 2-year Treasury yield, which is especially sensitive to expectations for monetary policy, climbed to around 4.41% on Wednesday, its highest level since January 2025. Markets were pricing roughly a 68% probability of a U.S. rate hike later in September, according to Reuters.This is important for the longer end of the bond market. If investors believe central banks will keep rates higher for longer, there is less reason to buy long-duration government bonds at previously prevailing yields.The market therefore isn't necessarily waiting for central banks to announce higher rates. Bond investors are already doing part of the tightening themselves.The AI boom is creating an unusual bond supply problemAnother factor differentiating the current environment is the enormous amount of corporate borrowing linked to artificial intelligence.The largest technology companies are spending hundreds of billions of dollars on data centres, chips and computing infrastructure. Increasingly, some of this investment is being financed through debt rather than entirely through internal cash generation.The five major AI hyperscalers — Alphabet, Amazon, Meta, Microsoft and Oracle — had issued around $220 billion of debt in 2026 by August, according to data cited by Reuters.The Bank of England has highlighted the scale of this development: hyperscaler investment-grade debt issuance in the first half of 2026 was broadly comparable with UK gilt issuance over the same period.That matters because investors have finite amounts of capital. A wave of highly rated corporate bonds offering attractive yields can compete directly with government debt. The result is another source of upward pressure on yields, particularly at the long end of the curve.Why higher yields could make bonds attractive nowThis is where the current selloff creates an interesting opportunity for investors.For years, ultra-low interest rates made bonds relatively unattractive. Investors could earn little income from government debt, encouraging capital to move into equities, corporate credit, real estate and other risk assets.That environment helped reinforce the equity boom of recent years. Strong earnings growth, particularly from technology and AI-related companies, has also allowed stocks to outperform despite increasingly expensive valuations.But the investment equation could be changing.A U.S. 10-year Treasury yield around 4.8% provides investors with a substantially higher starting income than was available during the zero-rate era. If yields eventually decline because inflation moderates or economic growth weakens, investors holding longer-duration bonds could also benefit from capital appreciation.This creates a potentially attractive two-part return profile: income today and potential price appreciation tomorrow.The comparison with equities is becoming increasingly relevant. Stocks can continue to outperform if earnings growth remains strong, but higher bond yields raise the discount rate applied to future corporate earnings. All else equal, that makes expensive growth stocks less attractive.Higher yields can also increase financing costs for leveraged companies and put pressure on highly indebted businesses. Hedge funds and other leveraged investors operating across multiple asset classes can also become more vulnerable when funding costs and volatility rise.None of this means investors should abandon equities. Strong corporate earnings, productivity gains from AI and resilient economic growth can continue supporting stocks. But it does challenge the idea that a portfolio should be overwhelmingly concentrated in equities simply because stocks performed exceptionally well over the previous few years.For diversified portfolios, bonds can also provide something equities cannot reliably offer: contractual income and, in high-quality government debt, a relatively defensive asset that can benefit if economic growth deteriorates and interest rates eventually fall.The current bond route is therefore not necessarily a reason to avoid fixed income. It may be the mechanism through which bonds become attractive again.For investors who spent the past few years riding the equity market rally, September's selloff is a reminder that portfolio construction should not be based solely on the asset class that performed best recently. With inflation, fiscal risks, geopolitical tensions and monetary policy all becoming less predictable, the value of diversification is rising.The question for investors is no longer whether bonds can outperform stocks in every scenario. It is whether, after this repricing, the income and diversification they offer are finally compelling enough to deserve a larger place in portfolios.Sources: Reuters, Eurostat, The Wall Street Journal, The Financial Times, The Joint Economic Committee, The House of CommonsThe information provided does not constitute investment research. The material has not been prepared in accordance with the legal requirements designed to promote the independence of investment research and as such is to be considered to be a marketing communication. All information has been prepared by ActivTrades (“AT”). The information does not contain a record of AT’s prices, or an offer of or solicitation for a transaction in any financial instrument. 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