By Adrian Tai Li-Aun
4 February 2025
Prefacing the bond market selloff
It comes as no surprise that global markets have been on edge since DeepSeek’s emergence in late-January. With the stock markets roiling and Nvidia having had US$600 billion or 17% of its market cap wiped from existence — a record one-day loss for any Wall Street company in history [1] — investors have begun seeking refuge in the bond market, driving the benchmark 10-year US Treasury yields down by nearly 10 basis points from 4.63% [2] on January 27.
However, for those who have not kept up religiously with financial markets, things were already shaken up before all the recent developments with DeepSeek due to a huge bond market selloff in early to mid-January. The financial impacts of DeepSeek’s launch have only driven an even more complex wave of uncertainty among investors due to its partial reversal of the bond selloff’s effects. While the duration of this reversal is yet to be determined, it is worth noting that the confluence of factors behind the earlier selloff have not disappeared.
So, what’s really happening and why?
The US 10-year Treasury yield reached as high as 4.799% on January 14, the highest it has ever been since November 1, 2023 — that’s more than 14 months.[3] Withal, the 30-year Treasury yield experienced an equally-notable 102 basis point surge from mid-September 2024, settling at 4.96% on January 10. [4]
The UK saw its 30-year gilt yields rise to 5.2-5.4% by mid-January while its 10-year gilt yields were trading around 4.6-4.8%, the highest they have ever been since 1998 and 2008 respectively. In addition, LSEG data showed that Japan, well-known for its negative interest rates regime which recently ended, have had its government bond yields rise above 1.2%, hitting a 13-year high. [5]
Meanwhile, the US 30-year fixed-rate mortgage rate, which tracks the 10-year Treasury yield, increased to 7.04% on January 16, up by more than 40 basis points during the same period in 2024. [6] It was around this time that many research houses expected this trend to persist, and while the trend has been slightly upended at the time of this article’s publication, it is likely to resume after the DeepSeek shocks have subsided. That said, this begs the question: why?
Inflation expectations
As mentioned earlier, there are a confluence of factors owing to the selloff, but the most significant driver are the inflationary concerns about the Trump administration’s large-scale protectionist trade policies, which lead with aggressive tariffs on an extremely wide range of products. Put simply, while the Fed had seemingly reined in inflation by the end of 2024 after a series of rate cuts, tapering, and quantitative tightening, Trump’s tariffs, along with other policies such as tax cuts and deregulation are expected to reignite considerable inflationary pressures and expectations, which is likely to reduce the number of rate cuts and increase rate hikes going forward into 2025. [7] Since Treasury yields are a global benchmark, this will lead to bond repricing on a global scale. Retaliatory tariffs against the US, as already shown by Mexico, Canada and China, are also expected to contribute to a sustained rise in global bond yields.
Growing fiscal debt concerns
Furthermore, concerns over the rapid rise in global debt levels are also contributing to the selloff. [8] There is already talk of what billionaire investor and Bridgewater Associates founder Ray Dalio coined as a ‘debt death spiral’ in the UK, and with the world having accumulated about $100 trillion in public debt [9], $36.1 trillion of which belongs to the US [10], it is highly doubtful that things will get any less alarming. To make matters worse, Fitch Ratings’ recent downgrade on the US credit rating has only intensified worries over its fiscal sustainability as a government’s credit rating is a strong indicator of its ability to repay debt. Put simply, the more fearful investors grow over governments’ fiscal health and rising debt levels, the more likely they are to demand higher yields to compensate for increased risk, raising the costs governments incur to service their debt. Coupled with the added pressure of inflation expectations, there could be a vicious cycle of rising debt, worsening investor sentiment, and by extension: increasing selloffs.
Corporate hedging
‘Hedging is a risk-management strategy that involves offsetting potential losses from an asset by taking an opposite position in a related asset… For instance, if you have long shares of XYZ corporation, you can buy a put option, which is a contract giving the buyer the right to sell a specified amount of a security at a predetermined price, to protect your investment from large downside moves. However, to purchase an option you have to pay its premium.’ – Investopedia
Focusing on US bond markets, the selloff was made worse when the corporate sector borrowed $190 billion as protection against future interest rate hikes in the form of what’s called a ‘pre-issuance hedge’ by short selling Treasuries in advance of their corporate bond issuance. [11]
These hedges function as a bet against US government bonds since Treasury yields are a benchmark for other rates in the economy, including corporate bond yields. Bond prices are inversely related to their yields, so if Treasury yields have risen when corporations issue their bonds, the hedge would pay out and offset the increased costs of servicing corporate debt. [12] Contrarywise, while corporations may lose money on the hedge if yields fall, they benefit from having to pay lower yields on the corporate bonds they issue. Albeit it is more probable that yields will rise in the long run.
Either way, the short selling of treasuries creates an added pressure point to the selloff, impelling the rise in yields in the long run as long as corporations continue to anticipate rising interest rates and take short positions in treasuries.
China
Herein lies another factor for the rise in yields that hasn’t yet been discussed extensively. As of August 2024, China is the second-largest holder of US national debt. They own roughly $768.6 billion worth of US Treasuries representing about 8.9% of foreign-owned US debt. [13]
Howbeit, ever since its peak of $1.3 Trillion in 2013, China has been gradually reducing its holdings of US Treasuries and replacing them with other alternatives such as gold. As such, if the People’s Bank of China were to continue this practice going into 2025, it would add yet another dimension to the rise in US’ bond yields, further fuelling the global bond selloff.
Broader implications
De-anchored inflation expectations
Due to Trump’s tariffs, the US is facing growing inflation expectations and the looming threat of runaway cost-push inflation; this bond market selloff is only going to exacerbate this problem and could well de-anchor inflation expectations. [14]
This is a textbook case of Muth’s Rational Expectations Hypothesis in action. Markets and economic agents are adjusting their behaviours based on anticipated policy and macroeconomic shifts. [15] This bond selloff itself reflects a forward-looking bet that inflation will rise sharply and remain persistent while interest rates stay higher for longer. If the Fed fails to re-anchor inflation expectations in time, the US risks plunging into a replay of its 70s-style-stagflation.
Much like the 1970s, an exogenous supply shock—then oil, now tariffs—risks fuelling price pressures, with firms pre-emptively raising prices and workers demanding higher wages. If the US enters an inflationary wage-price spiral, the Fed may be forced into aggressive rate hikes to regain control, risking a repeat of Paul Volcker’s infamous ‘Volcker recession’ in the aftermath of stagflation.
Emerging Markets
Rising Treasury yields will impel capital inflows to the US, strengthening the dollar. This will undoubtedly weigh on emerging markets and developing economies [16], as they are forced to raise their interest rates in lockstep with the US or risk a mass exodus of foreign capital. Countries with substantial dollar-denominated debt will also suffer from a rise in debt-servicing costs, further straining fiscal budgets, economic growth and compounding the global debt concerns mentioned earlier.
This is all before even considering the possibility that Trump’s tariffs might extend to certain EM countries [17], which will only worsen their economic outlook.
Closing Remarks
The bond market selloff is a testament to the precarious complexity of the current macroeconomic environment. With inflation expectations climbing, fiscal debt concerns mounting, and potential Chinese policy shifts, the impetus driving the selloff is clearly gaining momentum. While the more recent DeepSeek rally has slowed the bond selloff ad interim, the broader forces at work might suggest that the volatility in global bond markets is far from over.
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Researcher(s): Adrian Tai Li-Aun
Reviewer(s): Yeoh Jia Xin
Editor(s): Arisya
References
https://www.reuters.com/markets/rates-bonds/global-markets-yields-2025-01-08/
[8] https://economictimes.indiatimes.com/news/international/us/why-is-there-a-worldwide-bond-market-selloff-here-are-5-reasons-you-need-to-know/articleshow/117208342.cms?from=mdr
[3] https://www.cnbc.com/2025/01/14/a-global-bond-sell-off-is-deepening-as-hopes-for-multiple-fed-rate-cuts-fizzle.html
[11] [12] https://www.reuters.com/markets/rates-bonds/corporate-hedging-save-debt-costs-may-have-worsened-10yr-sell-off-2025-01-17/
[1] [2] https://www.reuters.com/technology/chinas-deepseek-sets-off-ai-market-rout-2025-01-27/
[9] https://www.weforum.org/stories/2025/01/public-debt-problem-davos-global/
[15] https://www.investopedia.com/terms/r/rationaltheoryofexpectations.asp
[14] [16] https://www.imf.org/en/Blogs/Articles/2025/01/17/as-one-cycle-ends-another-begins-amid-growing-divergence
[4] [5] https://www.spglobal.com/market-intelligence/en/news-insights/articles/2025/1/us-bond-market-selloff-shows-no-signs-of-stopping-87097407
[6] https://www.reuters.com/markets/us/us-30-year-fixed-rate-mortgage-flirts-with-7-2025-01-02/?
[10] https://www.americanactionforum.org/insight/the-united-states-breaches-36-1-trillion-debt-ceiling/#:~:text=The%20FRA%20suspended%20the%20debt,of%20debt%20outstanding%3A%20%2436.104%20trillion.
[13] https://www.investopedia.com/articles/markets-economy/090616/5-countries-own-most-us-debt.asp
[17] https://www.marketpulse.com/news-events/central-banks/global-market-outlook-2025-trends-risks-and-opportunities-for-traders/zvawda