Anthea Gardner, Managing Partner at Cartesian Capital
When The Economist asked on its cover in mid-October, “Will bonds blow up?”, it gave voice to a fear shared by many investors.
The US 30-year yield is at its highest level since the early 2000s. Someone who bought the 10-year Treasury on the eve of the Iran war would have surrendered more than two years’ worth of yield in capital losses.
Ed Yardeni, who coined the term “bond vigilantes”, quipped that the cover might be a signal to buy Treasuries. He has a point.
The Economist has a long record as an accidental contrarian indicator: by the time a fear makes the front page, the trade is often crowded.
Fear has a price in bond markets: the extra yield investors demand to lend to a government they no longer fully trust. France is paying that price in full. America, on the evidence, is not. US yields are rising because strong nominal growth implies a higher neutral rate, rather than a loss of confidence in America’s ability to manage its finances. That is a very different, and far less dangerous, story.
A fear with foundations
The federal deficit reached $2.0 trillion in fiscal 2026, or 6.2% of GDP, despite strong growth. Corporate tax receipts fell 16% following the One Big Beautiful Bill Act, while the Supreme Court’s ruling against emergency tariffs has triggered roughly $130bn in refunds. Net interest is the second-largest expense, and publicly held debt stands at around 100% of GDP.
These are serious concerns, but a deteriorating fiscal outlook does not automatically herald a bond-market crisis.
The US has a powerful countervailing force in its position at the centre of the AI revolution, with the potential to lift productivity and growth.
Fear fully priced: France
The gap between French and German 10-year yields has widened from 63bp at mid-year to over 140bp, close to its widest since the Eurozone crisis. France now pays more than Italy to borrow, unthinkable a decade ago.
France is protesting austerity while running a 5.4% deficit. Proposed savings include a fourth consecutive freeze in civil servants’ base pay and below-inflation pension increases. Yet these measures would reduce spending by just 0.2 percentage points of GDP.
America has a fiscal problem that markets are watching. France has one they are pricing.
Dusting for fear’s fingerprints
When investors fear for a government’s finances, the currency weakens, inflation protection becomes more expensive, auctions struggle and the risk premium climbs. Absolute Strategy Research recently tested for, and found little evidence of, US fiscal stress. We reach the same verdict, adding two tests of our own: the term premium and how bonds are priced against equities.
The dollar is rising, not falling. Since 27 February, the 10-year yield has risen more than 100bp and the dollar index nearly 5%. After the April 2025 “Liberation Day” tariff shock, the yield jumped 50bp in a week while the dollar fell 3.1%. That is what investors heading for the exit looks like.
Inflation fears are contained. Market-based inflation expectations have risen just 10bp this year to 2.35%. Investors who feared the debt would be inflated away would demand far more protection.
The risk premium has gone nowhere. Fiscal fear should show up in the “term premium”, the extra compensation for tying up money for ten years. The New York Fed’s estimate stands at 0.75%, where it began the year.
The distant future looks calmer than the present. The “10y10y forward”, the market-implied 10-year yield ten years from now, has risen just 32bp this year, about a third of the move in the 10-year. Investors are worried about interest rates, not the burden of debt.
Buyers are turning up. At September’s 30-year auction, primary dealers, who are typically expected to absorb any issuance not taken up by investors, took just 2.2% of the bonds on offer, their lowest share since at least 2012.
Bonds are starting to compete with stocks. The Fed model, which compares the S&P 500’s earnings yield (the inverse of its forward price-to-earnings ratio) with the 10-year Treasury yield, showed both at 5.24% on 9 October, leaving investors with little additional compensation for taking on equity risk.
14 October offered a real-time test. On 14 October, hot inflation data sent the 10-year yield up 13bp in under half an hour. As stocks slid, buyers stepped into Treasuries and the yield closed below its pre-data level. That is not how a market losing faith in a sovereign behaves.
The clearest tell is the simplest. The 10-year yield has risen 107bp this year, almost exactly matching the 112bp increase in the market-implied path of Fed rates. If fiscal fear were driving the move, these measures would diverge.
The real culprits
Warsh pulled the anchor on neutral. Under Jerome Powell, the Fed signalled rates were heading towards a lower “neutral” rate, anchoring long-end bond yields. Kevin Warsh dropped that guidance without offering a replacement. As yields climbed, he called it “the market doing the Fed’s work”.
Then the economy left Warsh little room to manoeuvre. Nominal GDP grew 6.3% year on year in the second quarter, and Warsh admitted he was “hard pressed to describe financial conditions as broadly restrictive.” With markets already pricing a hike, the Fed was boxed in and had to deliver one in September.
Markets were no longer following the Fed’s lead; they were doing its tightening for it. But when markets do the Fed’s job, the Fed cedes control of how far that tightening goes.
Japan stopped lending the world cheap money. Near-zero domestic rates made Japanese savers steady buyers of Treasuries and fuelled the yen carry trade. Both supports are fading. After hedging, Treasuries yield about 75bp less than Japanese government bonds, and Japanese investors have been net sellers of foreign bonds this year.
From Washington to Pretoria
South Africans know what a fiscal scare feels like, from Nenegate in 2015 to Moody’s 2020 downgrade. Since the GNU formed in 2024, the 10-year yield has fallen from above 12% to around 8.9%. Some of this is deserved, as debt is stabilising for the first time since 2008. But ahead of local government elections on 4 November, we think political risk is underpriced.
After two rate hikes took repo to 7.25%, markets priced in more than two further increases, well above the SARB’s projected path. We think this overshoots. Under the new 3% inflation target, the neutral rate falls to roughly 5.5–5.9%, leaving repo further above neutral than at the 2023 hiking peak. We see the recent hikes as insurance against an oil-driven inflation shock; rates have most likely peaked, although one further hike next year remains possible.
Our fair-value model builds the South African 10-year yield from the US 10-year yield, adding the CDS spread and inflation differential. A calmer reading of Treasuries is therefore, in good part, a calmer reading of our own market.
Where this leaves investors
At yields above 5%, the 10-year Treasury offers an enticing proposition: yields would need to rise by around 65bp over the next year to wipe out the income earned. If the economy wobbles or the AI trade falters, a 100bp fall in yields would deliver a total return of close to 13%.
In South Africa, we prefer shorter-dated bonds, where yields appear to price in too much further tightening. They offer scope to benefit if rate expectations ease, without the duration risk of longer-dated bonds ahead of the contested elections.
Magazine covers make great headlines, but fear always has a price. The opportunity lies in knowing when markets may not yet be charging enough for it, and when they are charging too much.
ENDS
