Bond selloff deepens as inflation, oil prices jolt markets

Global bonds suffered a significant selloff on Wednesday, pushing borrowing costs to multi-decade highs, as the Middle East conflict drove energy prices higher, fueling concerns about inflation and ballooning government debt. Sovereign yields, a key benchmark for asset prices, surged, with the U.S. 10-year note nearing a three-year high of 4.81%.

Japan's 10-year yield hit a 30-year high above 3%, while Australia's 10-year government bond yields climbed to their highest level in over 15 years at 5.198%. Germany's bund futures dropped to their lowest since 2011, and French OAT futures fell to a record low. Charu Chanana, chief investment strategist at Saxo, noted that bond investors are demanding higher premiums for inflation, fiscal risks, and the sheer volume of debt entering the market, which could drive yields above 5% for the U.S. 10-year.

Hyperscale tech companies raising funds for the AI boom have also put additional pressure on the sovereign bond market. The productivity gains from AI need to translate into higher wages for the economy to handle higher rates, according to Nomura Securities' chief macro strategist Naka Matsuzawa. Investors are closely watching the Federal Reserve's actions to address persistent inflation above its 2% target, with hawkish comments from Fed Chair Kevin Warsh last week fueling bets for additional rate hikes.

Rising energy costs continue to challenge policymakers, with Brent crude futures climbing 1% to $95.61 per barrel, after a 6% increase the previous session. The 2-year U.S. Treasury yield, often a proxy for Fed rate hike expectations, reached 4.41%, its highest level since January 2025. Traders anticipate a rate hike in Europe next week and roughly a 68% chance of a U.S. rate hike the following week.

The magnitude of the market shift is evident in Japan's government bond yields rising to above 3% for the first time in 30 years, reflecting concerns over Japan's fiscal outlook and global pressures on long-term funding costs. The rising yields have put Japan, Britain, France, and Germany under scrutiny, as their governments face mounting fiscal pressures and tighter monetary conditions.