Strong nominal growth carries a message for Treasury yields. Read more in today’s WSJ Economics newsletter:

The bond markets experienced a sharp decline on Thursday, with borrowing costs across the globe reaching their highest levels in decades. This situation has put significant pressure on government finances, stocks, credit, and other global assets. The 10-year US Treasury yield, which serves as a global benchmark for borrowing costs and asset prices, surged to 5.34%, marking its highest level since 2002.

Timothy Graf, Head of Macro Strategy for EMEA at State Street, noted that there is no single trigger for the sharp rise in yields. Instead, he believes that positions have been stopped out. The surge in yields can be attributed to the ongoing increase in central bank interest rates. French and Italian bonds have also been negatively impacted due to budgetary challenges during the financial year and the surge in demand from the AI sector.

The concern among bond investors extends beyond inflation, with mounting worries over large government deficits and the surging funding demand from the AI sector. Despite a milder US inflation print, it may not be enough to reverse the narrative. Meanwhile, doubts persist about whether central banks will successfully bring inflation under control in a swift and sustainable manner.

The economic and political realities of highly imbalanced growth make it difficult for monetary officials to implement rapid and decisive tightening measures that would benefit bond markets. It is essential to recognize that expansionary fiscal policies share the blame for persistent inflation, and the AI boom has led to increased demand for long-term capital, marking a structural shift from the pre-pandemic era.

The outlook for bond markets remains uncertain, with financial markets in the midst of a discovery process to determine the new long-term anchor for bond yields. Although a slight positive or negative surprise in a single inflation reading might not be enough to restore calm, it is a necessary step but not a sufficient condition to bring yields down swiftly.