Charts of the Week: Yielding Conclusions

Global bond markets The sell-off in bond markets has been a global phenomenon. This is illustrated in chart 1 showing the movement in 10-year government bond yields in the US, UK and Germany over the past 12 months. Still, as the chart’s scaling indicates, divergences in yield levels between the US and UK versus Germany suggest different dynamics have been at play. The US and UK, for example, have been leading the sell-off compared with Germany (and other eurozone members).

Global inflation expectations That suggests that inflation expectations coupled with inflation uncertainty have been a driver of higher yields. Chart 2 below shows the evolution of consensus forecasts for CPI inflation in 2025 across the US, UK, the euro area (and Japan) throughout 2024. Notably, expectations for inflation in the US and UK inflation rose steadily over the year. In contrast, euro area inflation forecasts remained relatively stable, hovering close to the ECB’s target of around 2%. We will focus more on this again below but for the record Japan’s inflation forecasts saw a gradual uptick, at the same time, but remained modest, increasing from 1.5% to just above 2%.

Overseas demand The role of overseas demand for US government debt in driving US yields higher could also have been significant. Chart 3 below shows the evolution of foreign holdings of US Treasury securities from 2013 to 2024, segmented by key regions: Japan, China, Europe, and the rest of the world. Over the period, total foreign holdings steadily increased, surpassing $9 trillion by 2024. Notably, Japan has now emerged as the largest single holder of US Treasuries, with its share growing significantly, while China’s holdings, though substantial, have showed some decline in recent years. But a new US administration led by President-elect Trump could now be further disrupting this picture. A potential pivot toward more protectionist policies alongside some question marks about the independence of the Fed and the dollar’s role as the world’s reserve currency could be combining to undermine overseas demand for safe-haven assets in the United States.

Japan Japan is worthy of some further separate comment in this regard. That’s because its capital flows are highly significant for global financial markets due to Japan's status as one of the world’s largest net creditor nations. Changes in Japanese capital flows—such as a shift back to domestic assets driven by rising yields or inflation expectations—usually create ripple effects, influencing global bond yields, currency markets (particularly the yen), and risk sentiment. This is why, notwithstanding relatively stable consensus inflation forecasts for 2025 that we noted above, the sharp rise in longer-term market-based inflation forecasts is noteworthy. Chart 5 below illustrates Haver’s calculations for the 5-year breakeven inflation rate in Japan from 2019 to 2024, and shows a sustained increase in those expectations in recent years. That follows several years of subdued expectations driven by entrenched deflationary pressures and weak demand. That the 5-year breakeven inflation rate crossed 2% toward the end of last year is also noteworthy given the Bank of Japan’s inflation objectives. For it potentially signals that monetary policy is still loose and that a further campaign to normalise policy beckons in the months ahead.

Quantitative tightening Central bank monetary policies more generally are also worthy of some discussion and particularly their balance sheet policies. Chart 5 below depicts the relationship between central banks' asset holdings as a percentage of GDP (a four-quarter change of an unweighted average for the US, Japan, and the euro area) and the real 10-Year bond yield in the US. The chart underscores the close connection between central bank asset purchases and real yields. In combination with looser US fiscal policy – and a higher degree of government bond issuance – the underlying supply and demand dynamics in the US Treasury market (and other government debt markets) have been shifting. Reduced demand from central banks, in other words, has coincided with additional supply from governments, and thereby amplifying upward pressure on real yields.

US and UK inflation The key takeaway from this discussion is that a confluence of factors has driven global yields higher in recent weeks. Inflation and monetary policy concerns, fiscal policy uncertainty, and shifts in capital flows have all likely contributed. As highlighted earlier, the trajectory of yields from here will hinge on incoming economic data and how policymakers respond. On that first point, however, it was notable that this week brought some encouraging news: the latest CPI inflation reports from both the US and UK came in weaker than expected. Notably, the details were also reassuring, with service-sector inflation showing further signs of moderation in both economies (see chart 6 below). This could ease some of the pressure on central banks to keep monetary policy restrictive in the period immediately ahead.