Global Bond Markets Reel as U.S. Credit Downgrade and Trump’s Tax Bill Spark Fiscal Fears

A global sell-off in government bonds has intensified, driven by a recent U.S. credit rating downgrade by Moody’s and mounting concerns over President Donald Trump’s proposed tax bill, which could balloon the U.S. deficit by $3 trillion to $5 trillion.

The U.S. 30-year Treasury yield surged past 5% for the second consecutive day, reaching 5.088%, a level not seen since November 2023, while the 10-year Treasury yield climbed over 15 basis points this week to 4.59%.

This rout, which began with an exodus from U.S. Treasuries in April, has spread to major markets like Japan and Germany, reflecting investor unease about worsening fiscal trajectories and declining confidence in U.S. assets. As bond yields spike, fears of rising borrowing costs and economic instability are rattling global financial markets.

U.S. Fiscal Concerns Trigger Treasury Rout

The catalyst for the bond market turmoil lies in Washington, where Moody’s downgrade of the U.S. credit rating last Friday highlighted the nation’s $36 trillion debt pile. Trump’s tax bill, which faced resistance from GOP lawmakers wary of its deficit-expanding potential, has further eroded investor confidence.

Despite failing to pass, the proposal’s projected $2 trillion to $5 trillion addition to U.S. debt over a decade has spooked markets, with analysts noting that investors are demanding a higher term premium to hold long-dated bonds.

“Markets do not find Trump’s ‘big, beautiful tax bill’ beautiful at all,” remarked a managing director at Mizuho Securities, capturing the sentiment driving the sell-off. Recent market data shows the gap between 10-year Treasury yields and swap rates has widened to 64 basis points, the largest on record, signaling heavy selling pressure.

Global Contagion: Japan and Germany Feel the Heat

The bond sell-off has rippled beyond the U.S., with Japan and Germany experiencing significant yield spikes. Japan’s 40-year government bond yield hit a record 3.689% on Thursday, while its 10-year yield rose 9 basis points to 1.57%.

This steepening yield curve is partly due to structural shifts, as Japanese life insurers, no longer bound by solvency regulations, have reduced purchases of long-term bonds. The Bank of Japan’s tightening monetary policy has also fueled the sell-off, making Japanese assets more attractive and encouraging divestment from U.S. Treasurys.

In Germany, the 30-year bund yield jumped over 12 basis points, driven by the removal of the country’s debt brake and increased defense spending under the EU’s ReArm Europe plan, which could require €800 billion in borrowing. These developments signal a broader reassessment of fiscal risk across major economies.

Did You Know?
The U.S. Treasury market, valued at $29 trillion, is the world’s largest bond market, traditionally seen as a safe haven, but its safe-haven status is now under scrutiny due to fiscal uncertainties.

Emerging Markets Buck the Trend

While developed markets grapple with rising yields, some emerging markets have seen their bond yields decline. India’s 10-year government bond yield dipped by 2 basis points since Monday, and China’s 10-year yield also slipped marginally.

Analysts attribute this resilience to domestic market dynamics and capital controls, which shield these economies from global volatility. “Foreign investors and global factors are far less relevant for their yield curves,” noted an Asia strategist at Robeco.

This divergence highlights the uneven impact of the global bond rout, with emerging markets like Brazil and Mexico also seeing inflows into local currency bonds as investors seek alternatives to U.S. debt.

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Economic Implications and Investor Sentiment

The bond sell-off is raising alarms about its broader economic impact. Rising yields increase borrowing costs for governments, businesses, and consumers, potentially stifling growth. In the U.S., mortgage rates could climb above 7%, and corporate borrowing costs are already under pressure.

Concerns about global inflation, described as a “killer” for long-duration bonds by a chief strategist at Interactive Brokers, are compounding the sell-off. The Federal Reserve may face pressure to intervene if yields continue to spike, with some analysts suggesting emergency Treasury purchases could be necessary to stabilize markets, as seen in the UK in 2022.