An Invidious Choice? Towards Bond Market Crisis or Yield Curve Control

What You Need to Know

The yields on long bonds have risen to multi-decade highs. Debt sustainability fears have festered for years but to no tangible effect—either on investment portfolios or political debate. The most likely route is that the “can is kicked” on both debates; after all, >2% real yields will be tempting to many investors.

Nevertheless, in this note we think about the possible next stage. The political stance on deficits is just not serious on either side of the Atlantic. Politicians inhabit a land of make-believe. The demands of retirement savings and the coming rebalancing of pension assets away from nominal duration implies that a change will come.

We take the unpopular stance that a bond-market crisis would be a good thing, as probably the sole route to engender change and avoid worse intergenerational tension later. However, in practice politicians might balk and stop yields from rising by fiat, thereby triggering inflation and currency implications.

How bad would higher yields be for equities? So far, this rise has been masked by AI-led upward revisions to expectations, but we think that techno-optimism is naïve. Still, we think a strategic pro-equity position is still warranted.

This is a global problem, though the specifics vary. The US has growth (at least for some) but short debt maturity, European countries lack growth and are worryingly dependent that pension plans want to buy their bonds. Investors have not learned, despite 2022’s experience and the UK’s Liz Truss moment. They still believe in the myth of “risk-free assets.” Any current calm is not an equilibrium.

Additional Contributors: Alla Harmsworth, Robertas Stancikas and Maureen Hughes

The rise in bond yields in 2026 raises questions for investors and governments about what comes next. After six decades of climbing government debt and at least a decade of fretting about what level would be unsustainable, is this a sign that markets are taking a firmer line? Does US Treasury Secretary Scott Bessent’s double intervention during August— in the yen and US long-bond markets—imply a more overt, fiscally led, approach to this issue? In the longer sweep of history, today’s yields are not exceptional, but they raise strategic questions about asset allocation and government funding against a cavalier approach to deficits in many major economies and an inexorable tilt in the allocations of pension systems away from bonds.

In this note, we consider options for the way forward in the longer term. We are explicitly not going to opine on what this means for near-term Fed policy, as we keep the focus strategic. Some have suggested that, because it is real yields and not inflation expectations that have risen, this is at most a benign sign of future abundant growth. We are not so sanguine. This is a theoretical argument based on equilibria of recent decades that may not apply any longer. Growth is indeed very strong in the near term. Yes, there is an artificial intelligence (AI) reason why it could be high long term as well. However, equally other aspects of that could go wrong (political backlash and rising inequality, for example), so it seems equally likely that higher yields reflect a term premium of long-run distrust in fiscal policy and a questioning of the demand for nominal assets. One could also suggest that higher long rates are purely a function of investors wishing to price in higher near-term rates, but that notion sits uneasily with a yield curve that is as steep as it has been in years.

Another potentially significant change has been the proposal by Norges Bank, in its September 2026 submission to Norway’s Ministry of Finance,  to reduce government bonds from 70% to 50% of its fixed income benchmark, while not making an overall change to the fixed income exposure or to its geographic footprint. This recognizes that long-horizon investors do not need such a large allocation to sovereign duration for liquidity and diversification. It also shows that such views are not necessarily fixed income negative in general; they are more about the role of nominal duration, particularly in a strategic asset allocation (SAA) context, and the desire to allocate to other areas—be it inflation-protected bonds, active allocation in credit or potentially private debt.

There are a few options for the way forward. Very broadly, either: things can stay as they are, “crisis deferred;” yields could continue rising to levels that are painful for governments and investors; or governments could become more proactive in stopping yields from rising.

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¹Please see: "The Government Pension Fund Global – analyses and assessments of the investment strategy for bonds"
https://www.nbim.no/en/news-and-insights/submissions-to-ministry/2026/the-government-pension-fund-global--analyses-and-assessments-of-the-investment-strategy-for-bonds/