Surging bond yields and fiscal crisis ‘remain unlikely’

Core government bond yields are expected to trend upwards over the next five years but a big surge looks unlikely, according to consultancy Oxford Economics.

“Even our most downbeat scenario implies only moderate rises in debt service costs, suggesting governments will be relaxed about rising yields,” wrote economist Adam Slater in a report published December 2. 

Core government bond yields have been low for more than a decade, helped by excess global demand for certain government bonds seen as ‘safe assets’.

But there are historical examples of yields surging after long periods during which they’ve been low and steady, such as in the US in the 1960s-1970s.

Model scenarios

Oxford Economics ran a series of model scenarios that simulated the impact of factors such as a sharp rise in government debt, curtailed quantitative easing (QE), reduced demand for core currencies as FX reserves, and higher inflation.

Individual shocks to supply and demand for these safe assets add an extra 14-70 basis points (bps) to yields, according to Oxford Economics.

A combined shock adds an extra 130bps to US 10-year yields by 2025, going to 3.5% from the consultancy’s current baseline of 2.2% and 0.9%.

“The rises in yields generated in our scenarios look small by historical standards, although they would imply quite large price changes in bonds given the low starting level of yields,” Mr Slater wrote.

Rising yield risks

Some of the individual shocks could result in investors suffering losses similar to those in 1994 or 2013-2014, according to Oxford Economics.

In the combined negative scenario, losses could approach those seen in 1965-1970, Mr Slater wrote.

“Rising bond yields feed into higher government debt service costs only gradually, especially when average debt maturity is long. As a result, most governments are likely to be quite relaxed about rising yields, and these should not be a big barrier to continued loose fiscal settings,” Mr Slater wrote.

“Investors cannot rely on the reimposition of austerity to help limit their downside this time around.”