The battle against rising US Treasury yields

WITH benchmark US Treasury yields breaking above 5.3 per cent in October, rising bond yields are now at the forefront of investor concerns against the backdrop of America’s US$40 trillion in debt outstanding.

However, as highlighted in our June column: “What the US can do to control rising yields”, what is critical for the US and other economies around the world is to not necessarily keep yields down, but rather, keep funding costs below the rate of nominal growth in their overall economy.

The consequences of being unsuccessful at doing so are apparent across the history of some emerging markets, and the developed world as well.

Examples in history

Most recently, this was illustrated in 2011 when Italian yields spiked amid the Greece-induced eurozone crisis, just as the 2007 to 2008 global financial crisis depressed economic activity around the world.

Concerns about an Italian default surged, as borrowing costs rose. It took the European Central Bank’s extraordinary intervention to purchase Italian and other European debt, and maintain zero interest rates for the next decade to quell the ensuing crisis.

Unfortunately, examples of the consequences of the rising costs of debt service in heavily indebted economies go back much further.

In the UK, since 1960, crossovers between sovereign funding costs and economic growth rates coincided with devaluations of the British pound in 1967; again in 1980 to 1984; the exit of the UK from the European Exchange Rate Mechanism in 1992; and in 2008 to 2009, the UK banking crisis.

The US likewise experienced its own stress when funding costs rose above economic growth rates.

Recall in 1971, the US ended the convertibility of the greenback into gold established under the post-World War II Bretton Woods Agreement. This devalued the US dollar relative to gold, as the burdens of Vietnam War and 1960s social spending expanded US deficits.

Now with the autumn surge, bond yields are getting uncomfortably close to the 6.3 per cent nominal gross domestic product growth registered in the second quarter of 2026, just as the US dollar hegemony is weakening.

Indeed, the Treasury has already begun to deploy one of the tools outlined in our aforementioned June column: an expansion, albeit still modest, of its buyback programmes.

However, Treasury Secretary Scott Bessent has been successful only at smoothing the back-up in bond yields, rather than blunting the rising trajectory of US sovereign funding costs in place since early-2026 altogether.

Optimists can indicate some potential catalysts to ease the upward pressure on yields.

The recent agreement by the Group of Seven nations – US, UK, Germany, France, Canada and Japan – to release 50 million barrels each of crude oil and diesel fuel to relieve the pressure on global energy markets could help quell concerns of a renewed surge in energy inflation in the global economy.

This comes as the initial March surge in energy prices has yet to translate into wider price pressures in the US economy, as core inflation eased back to a modest 2.4 per cent in August.

Partially because of this, Philip Jefferson, vice-chairman of the US Federal Reserve, and John Williams, president of the Federal Reserve Bank of New York, have played down the prospect of an October rate hike.

This caused markets to begin unwinding the expectation of a prolonged rate-hiking cycle priced in after the central bank’s September rate move.

However, risks of higher bond yields linger. US inflation expectations remain surprisingly well behaved with two, five and 10-year inflation expectations still near 2.5 per cent.

This suggests markets are pricing only a transitory impact of the 2026 energy crisis on medium to long-term inflation.

It is despite the fact that 12-month Brent crude futures, which have historically led trends in medium-term inflation expectations, have returned to their March 2026 highs.

A third US aircraft carrier is steaming towards the Middle East and is set to arrive on station in November. Should this signal a potential restart of hostilities in Persian Gulf, potentially expanding into a Red Sea theatre of operations, bond yields around the world may yet have to price higher-for-longer inflation into 2027 if energy prices continue to rise.

Fortunately for bond investors, Bessent still has measures that can be deployed in the coming months to seek to stall, even if temporarily, the crossover of bond yields and nominal GDP growth.

First, the modest US$30 billion in Treasury buybacks deployed in September can be scaled up by a magnitude.

This may already be happening. From a peak balance of US$980 billion held in the Treasury’s “checking account”, the Treasury General Account, despite the influx of quarterly tax revenues, nearly U$100 billion has been drawn down.

This suggests wider buybacks may have taken place to help Treasury yields pull back from the 5.3 per cent level in early October.

The US government could draw an estimated US$280 billion to continue battling bond vigilantes, either via buybacks or reduced long-term Treasury issuance in its November refunding announcement.

The gold-revaluation option

Beyond this, Bessent may need to turn to a more untraditional tool to replenish his arsenal – the revaluation of US gold reserves. The US is the only major economy in the world that does not currently mark its gold reserves to market regularly.

In fact, only one other major economy has resorted to revaluing gold reserves in the past in anticipation of fiscal shortfalls.

In 1997, then-German chancellor Helmut Kohl and the finance minister at the time, Theo Waigel, proposed a revaluation of the country’s gold and foreign-exchange reserves, with the revaluation gains to be used to offset deficits elsewhere in the German Budget and help meet Maastricht targets for joining the euro area.

However, the German revaluation, equivalent to 0.5 per cent of GDP, pales in comparison to the potential revaluation gains that the US could generate.

Indeed, America’s 8,100 tonnes of gold reserves are carried at US$42.22 per ounce, or US$11 billion. Should US President Donald Trump choose to revalue reserves to current market prices of gold, he would generate more than US$1.1 trillion in revaluation gains or close to 3 per cent of GDP.

Such gains could then be transferred into the Treasury General Account, allowing the US Treasury Secretary to perhaps forgo a more substantial amount of new long-dated Treasury issuance, compressing supply and easing upward pressure on US bond yields.

Alternatively, the US$1.1 trillion in revaluation gains could provide additional firepower for a significant upsizing of the Treasury buyback program.

In this landscape, we continue to believe that periodic spikes in bond volatility should remain a key feature of the investing landscape looking ahead.

However, whereas the risks highlighted in our June column cited asymmetric risk of higher yields, investors should now expect increasing two-way risk for Treasury yields as the Treasury deploys its policy toolkit more forcefully in the months ahead.

For investors, such a backdrop continues to suggest that credit risk rather than interest rate risk should be their preferred focus in generating total returns in bond portfolios.

Moreover, the merits of moving off the US dollar yield curve and onto select emerging market local currency yield curves offer high yielding, alternative and comparatively uncorrelated return drivers.

A new equilibrium is sought by markets due to the overhang of the worsening debt and deficits globally.

The writer is group chief strategist at Union Bancaire Privee