A different perspective on rising government bond yields

By Joe Aylott, Multi-Asset Strategist

• The rise in government bond yields may owe more to economic strength than to mounting inflation or fiscal concerns, helping to explain why equity markets have remained resilient.
• Government debt has had an impact, but the more significant story has been economic growth consistently beating expectations globally this year.
• Government bonds are beginning to offer investors a more attractive balance of income and diversification potential. For now, however, our preference remains with global equities.

Rising bond yields and resilient equity markets may look at odds. In fact, they share a common thread.

Economic growth has supported corporate earnings, underpinning equity markets in 2026. At the same time, it has pushed government bond yields higher.

What matters for investors is whether those higher yields reflect economic strength or mounting risks.

The value of investments, and the income from them, can fall as well as rise and you may not get back what you put in. Past performance should not be taken as a guide to future performance. You should continue to hold cash for your short-term needs. This article should not be taken as advice.

What is really driving government bond yields higher?

Government bond yields have risen across major markets this year, but higher long-dated yields are not inherently negative. A rise driven by concerns over inflation or government debt sends a very different signal from one driven by stronger economic growth and improving productivity. Evidence from the US Treasury market increasingly points towards the latter.

To understand what is driving this broader rise, the 10-year US Treasury provides a useful guide. Since the start of the year, the 10-year US Treasury yield has risen from around 4.17% to 5.25%. Over the same period, bond market expectations for average inflation over the next 10 years have increased only modestly. This suggests inflation concerns account for only a small part of the rise; most has come from increased economic growth expectations and higher ‘real’ yields – the return investors expect after allowing for inflation.

The economic backdrop supports this interpretation. US unemployment claims remain historically low, our analysis points to limited recession risk and economic growth remains robust. Since 2020, US nominal GDP – economic output before adjusting for inflation – has increased by around 50%, equivalent to annualised growth of roughly 6%.

This helps explain why equities have broadly absorbed higher bond yields. Equities have become less expensive relative to earnings (a process known as ‘de-rating’) this year, partly as a result of higher interest rates, but rising earnings meant this has occurred without markets falling. (Find out more in our recent CIO Weekly: A painless reset for equity valuations?)

This earnings growth extends beyond a handful of large companies, with earnings per share also rising across the equal-weighted US equity index. Rate-sensitive sectors (such as real estate) have faced greater pressure, but the wider market has remained resilient. In Q3 this year, all 11 sectors in the S&P 500 index are expected to deliver positive year-on-year growth for both revenues and earnings.

How much do government debt levels matter?

Rising government debt has become a popular explanation for higher yields. But while fiscal sustainability matters, current bond market pricing suggests investors do not yet view it as the dominant risk.

Debt sustainability is not only a function of borrowing, but also of economic growth. Since the start of 2022, US federal debt has increased by more than $10 trillion, or roughly 6% a year. However, debt as a share of GDP has risen by only a few percentage points because the nominal value of the economy has grown at a similar pace.

One useful measure is the US yield curve – which shows how government borrowing costs vary across shorter and longer periods. Typically, investors concerned about debt sustainability would likely demand much higher returns to lend over longer periods. Despite US government debt standing at around 120% of GDP, the gap between two- and 30-year Treasury yields remains relatively modest by historical standards, at around 80 basis points (0.8%).

This suggests bond markets are responding less to fiscal stress than to an economy that has proved far more resilient than many expected.

Higher yields are improving the case for bonds

Higher yields have improved the balance of risk and return for bond investors. The additional income provides a greater cushion if yields rise further, while slower economic growth and central bank rate cuts could push yields lower and bond prices higher.

Bond returns reflect both the income received and changes in the bond’s price. To illustrate, if yields on US Treasuries, currently 5.25%, rose by a further 100 basis points over the next 12 months, today’s higher income could largely offset the resulting fall in bond prices. An equivalent fall in yields, however, could produce a total return of around 10-11% (based on current market conditions) through a combination of income and rising bond prices.