The bond conundrum

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BOND yields are set to remain a major test for investors even as inflation, oil prices and government borrowing costs push long-term rates higher across major economies.

But yields approaching multi-year highs are not necessarily seeing investors rush to exit stocks, with strong corporate earnings and artificial intelligence (AI)-led growth still giving equities room to absorb the pressure.

The key question for markets now is whether the rise in yields is simply part of a post-pandemic normalisation or a more lasting shift towards higher borrowing costs, heavier government debt and weaker demand for long-dated bonds.

Aberdeen Investments chief economist Paul Diggle says the rise is being driven by both cyclical and structural forces. While higher central bank interest rates explain part of the increase, an additional selloff has emerged since late June.

Long-term bond yields in the United States, the United Kingdom (UK), Germany, France and Japan have risen by between 20 basis points (bps) and 70 bps from their late-June lows. In the US and the UK, the increase is around 40 basis points.

“That is a meaningful rise,” Diggle says, noting some yields have already risen to multi-decade highs.

Mounting pressure

The immediate drivers include inflation concerns, geopolitics and changing expectations for central bank policy.

Oil prices close to US$100 a barrel are adding to concerns that the energy shock linked to the Iran conflict could last longer than initially expected.

That raises the prospect of stickier inflation and, in turn, interest rates staying higher for longer. At the same time, expectations around the US Federal Reserve (Fed) are becoming more hawkish.

The bigger issue, though, may be structural.

“The supply of bonds has been rising because government debt and deficits are high,” Diggle says. “Meanwhile, the demand for bonds, especially at the longer end of bond curves, has been moderating for several interesting reasons.”

Governments across developed economies are issuing more debt as they deal with ageing populations, welfare spending, defence requirements and energy support.

Debt-to-gross domestic product ratios are already above 100% in the UK, France and the United States, and above 200% in Japan.

At the same time, a new source of bond supply is emerging from the technology sector.

Large US technology companies, particularly the hyperscalers, are increasingly financing the AI build-out through debt rather than relying mainly on cash flow and profits.

The hyperscalers have issued perhaps US$200bil of debt over the past year, according to Diggle, while companies involved in AI use cases have issued at least US$400bil.

Much of that borrowing is at the longer end of the curve, putting these companies in direct competition with governments for investors’ money.

Changing demands

Demand for long-dated bonds is changing. Pension funds and life insurers have become less compelled to buy bonds after higher yields improved their funding positions.

Defined-benefit pension funds that were previously in deficit have moved into surplus, reducing the need to buy long-dated bonds to match liabilities.

Central banks are also no longer buying debt like they used to. This creates a straightforward market problem: more bonds are looking for buyers, while some of the traditional buyers are becoming less active.

Prices therefore need to fall, which means yields must rise to attract sufficient demand.

Bonds have traditionally provided diversification when stocks fall, forming an important part of the classic 60-40 portfolio.

But inflation and supply-side shocks are making bonds and equities more likely to move in the same direction.

That means bond investors may demand more compensation for holding long-term debt.

The implications are now spreading into equities.

Impact on equities

Bloomberg reports that Wall Street strategists are increasingly drawing comparisons with the late 1990s, when technology stocks managed to perform strongly despite rising interest rates and Treasury yields before the dot-com bubble eventually burst.

Yet, that is not prompting investors to abandon stocks.

The S&P 500 has barely moved since the beginning of June after rising 11% in the first five months of 2026 and posting double-digit annual gains in each of the previous three years.

The market’s resilience is particularly striking because investors are facing several headwinds at once.

“The stock market is acting like a duck,” Drew Pettit, chief investment strategist at Roundhill Investments, tells Bloomberg.

“It’s calm on the surface, but it’s just paddling like the dickens underneath.”

For now, investors appear more willing to sit through the volatility than to risk missing another leg of the bull market.

“The greater risk is missing the last leg of a bull market where you generate these outsized returns,” Michael Rosen, chief investment officer at Angeles Investment Advisors, tells Bloomberg.

That does not mean investors are ignoring the bond market.

Bloomberg notes that equity sentiment has slipped only slightly into neutral territory, while bond-market sentiment has fallen to its lowest level since 2022, according to Ned Davis Research.

There are also signs of greater selectivity. The Cboe Volatility Index remains subdued, but the gap between index-level and single-stock volatility has risen to its highest level in more than a decade.

Chris Harvey, head of equity and portfolio strategy at CIBC Capital Markets, tells Bloomberg that “growth and tech can power through a tightening cycle”, pointing to the technology-heavy Nasdaq 100’s 59% rise between June 1999 and May 2000, even as the Fed was raising rates.

That same resilience is partly visible today.

Strong earnings are helping to cushion the impact of higher yields, while technology companies continue to benefit from the AI investment cycle.

The S&P 500 Information Technology sector is trading at 20.5 times estimated earnings for the next 12 months, down from almost 26 times at the beginning of June and below its 10-year average of 23 times, according to Bloomberg.

“Earnings have overwhelmed” the macroeconomic risks, Keith Lerner, chief investment officer and chief investment strategist at Truist Advisory Services, tells Bloomberg.

S&P 500 companies are expected to post their third consecutive quarter of more than 20% earnings growth when results arrive next month, according to Bloomberg Intelligence.

Timothy Holland, chief investment officer at Orion, says investors who can make it through the current period of uncertainty could find the next earnings season more supportive.

For Diggle, however, rising yields should not automatically be treated as a signal to sell equities.

What matters is why yields are rising, how quickly they are moving and how large the move becomes.

“There can be good or bad reasons for bond yields to rise,” he says.

Higher yields caused by stronger growth and productive investment are very different from yields rising because of persistent inflation or concerns about government debt sustainability.

The AI-related increase in corporate borrowing, for example, is partly funding real-world infrastructure investment that could generate stronger growth and productivity.

So far, Diggle says the increase in the US and the UK 10-year and 30-year yields remains roughly a one-standard-deviation move.

Historically, a sustained equity-market headwind tends to emerge after larger moves.

The danger rises if the selloff accelerates. A rapid move above 5% or 5.2% in the US 10-year yield could create a more sustained drag on equities.

That is why the bond market is increasingly important for investors watching stocks.

Higher yields raise the discount rate applied to future earnings, making them particularly challenging for growth companies whose profits are expected further into the future.

They also raise borrowing costs across the economy.

But a higher yield by itself is not necessarily the problem.

“The framework should be not that any given level of bond yields is problematic, but the why, the speed, the size of the move, that’s what really matters,” Diggle says.

Source: The bond conundrum (Saturday, 19 Sep 2026) The Edge Malaysia. Retrieved from https://www.thestar.com.my/business/business-news/2026/09/19/the-bond-conundrum

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The bond conundrum

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