By John Authers The tectonic plates of the global economy have shifted. Across the world, yields on long government bonds — keystone of the entire financial system — have climbed to their highest in decades. A trend that had been clear ever since the brief post-pandemic boom turned into resurgent inflation and higher rates has suddenly accelerated.

In Japan, 10-year bonds now yield the most in more than three decades. In other major markets, government borrowing costs are their highest since the eve of the Global Financial Crisis 19 years ago, and rising at a pace that hasn’t been seen since long before then:

In financial terms, this is truly an earthquake. What is strange, however, is that even though 10-year government bonds are the financial bedrock, setting the risk-free rates from which virtually all transactions are ultimately priced, they are showing little sign of damaging anything else, either in the markets or the real economy. The Nasdaq 100, one of the world’s most widely tracked indexes, hit a new all-time high this week even as yields were tipping upward. That is ultimately because their rise is still viewed — rightly or wrongly — as benign.

Many factors drive the bond market, but it’s hard to argue that any of the more alarming ones is responsible for the shift. Among frequently cited problems that don’t appear decisive on closer inspection are:

The most logical explanation for bonds’ upheaval is also one of the most palatable. Economic data have been much stronger than expected of late. In combination with a surprisingly aggressive approach from the new Federal Reserve Chair Kevin Warsh, that has prompted markets to price in overnight US rates of 4.75% a year from now. Before the Iran war, they were expected to fall to 3%.

The most logical explanation for bonds’ upheaval is also one of the most palatable. Economic data have been much stronger than expected of late. In combination with a surprisingly aggressive approach from the new Federal Reserve Chair Kevin Warsh, that has prompted markets to price in overnight US rates of 4.75% a year from now. Before the Iran war, they were expected to fall to 3%.

It’s difficult to couch a sudden increase in the cost of borrowing money for the long term as good news. But there are some positive implications. If a virtually risk-free investment will now pay a guaranteed 5% for 10 years, that becomes a viable alternative to stocks — or at the very least it allows for more effective risk management. Traditional pension plans, which define benefits for their savers in advance (rather than allowing them to move with the market), fund their guarantees by buying bonds. The higher the yields on offer, the cheaper it is for them to do this. Thus the possibility of a pension crisis, particularly for relatively low-paid public employees where such plans still predominate, is reduced.

There’s also a traditional libertarian argument that a higher cost of money could be exactly the medicine that capitalism needs by forcing companies to spend on projects that have a real chance of generating a return. This follows almost two decades when yields were held unnaturally low by policies such as quantitative easing, or QE, which made it easier to turn a profit just by financial engineering. Ian Harnett of Absolute Strategy Research in London argues: He also contends that higher yields will make life harder for the many non-bank financial lenders that have flourished over the last decades. The disquieting analogy here would be with 2007, when the last spike in 10-year Treasury yields above 5% was the catalyst for financiers to retreat from arcane structured-credit products based on sub-prime loans. It’s not clear, however, that the current non-bank lending is as widespread as shadow banking was then. Harnett says that another retreat would further discourage companies from relying on financial engineering rather than productive investments. Nevertheless, there are risks in such a sudden shift in the market landscape, particularly if yields keep rising. Fiscal problems don’t appear to have driven yields higher — but rising borrowing costs might push strained government finances to crisis point.

This is not a major issue for the US, which has the advantage of the world’s reserve currency and also starts with a very low tax burden. Higher taxes, particularly for the wealthy, might cause serious problems in the longer term, but in the short term would swiftly assuage any worries about Uncle Sam’s ability to repay debt.

This is not a major issue for the US, which has the advantage of the world’s reserve currency and also starts with a very low tax burden. Higher taxes, particularly for the wealthy, might cause serious problems in the longer term, but in the short term would swiftly assuage any worries about Uncle Sam’s ability to repay debt.

The rise in yields is a global phenomenon, and as the chart above shows, it has been most extreme for countries with obvious fiscal issues — notably Japan, where gross debt is almost 250% of GDP, and France, which as part of the euro zone doesn’t control its own monetary policy. French borrowing costs have not only risen in absolute terms, but they are now 1.1 percentage points above equivalent yields in neighboring Germany. The gap between the two had only been higher for a few months during the worst of the euro-zone’s sovereign debt crisis in 2011 and 2012. This implies that again the market is perceiving France as far riskier than Germany, even though both are bound by the same currency.

Nobody wants a repeat of that crisis. But with France likely to elect as president a far more nationalistic politician next year, while Germany appears to be turning inward and less inclined to help out, there is a growing risk that the shift in the financial tectonic plates could lead to a political earthquake in the euro zone.

But such aftershocks, if they happen, are for the future. For now, despite everything, the ground beneath our feet remains stable. OPIN To contact the author of this story: at jauthers@bloomberg.net

OPIN To contact the author of this story: at jauthers@bloomberg.net