Government bond yields in several developed economies have reached their highest levels since mid-2024. While there are similarities in the direction of bond market movements, the underlying drivers vary significantly.
In brief
- Developed market government bond yields have spiked in recent weeks due to a combination of reasons, ranging from solid growth in the U.S. and a hawkish Federal Reserve (Fed), to fiscal concerns and political uncertainties.
- There is a lack of appetite to raise taxes and reduce spending. In some developed economies, such as the euro area, more spending could be needed to support growth and facilitate the green transition and boost national defense.
- Our current outlook suggests support for a short-duration bias for U.S. Treasuries, allowing investors to take advantage of decent yields without excessive exposure to duration.
Yields on the rise, but why?
Government bond yields in several developed economies have reached their highest levels since mid-2024. While there are similarities in the direction of bond market movements, the underlying drivers vary significantly. Overall, the medium-term outlook appears more favorable for European government bonds compared to those in the U.S.
Inflation expectations have played a limited role in driving recent increases in government bond yields. Exhibit 1 illustrates the breakdown of changes in inflation breakevens and the residual, which is the change in real yield. Apart from Japan and Canada, the rise in real yields accounts for much of the increase in nominal yields. This is logical, as many factors that drove higher inflation in 2021-2022 have largely dissipated. The connection between higher energy and food prices and geopolitical events has weakened substantially. The post-pandemic pent-up demand for services and bottlenecks in restoring these services have also subsided. High interest rates over the past two years have cooled economic momentum, particularly in the UK and the euro area.
Exhibit 1: Change in 10-year government bond yields since 30 September 2024
Basis points
Source: LSEG Datastream, J.P. Morgan Asset Management.
Data reflect most recently available as of 10/01/25.
Idiosyncratic domestic factors the main drivers
Domestic factors are critical in explaining the rise in real yields for each country. Questions over fiscal sustainability are common in several markets. In the U.S., the incoming new administration, with the Republican party controlling the White House and Congress, could be looking to maintain a high deficit fiscal policy. The likely extension of the 2017 Tax Cut and Jobs Act (TCJA) could accelerate the rise in U.S. federal government debt. The federal debt-to-gross domestic product (GDP) ratio could increase from the current level of 99% to 128% by 2035 if the TCJA is extended, potentially leading investors to demand a higher risk premium for a higher debt burden.
Furthermore, the Fed’s cautious approach to rate cuts this year is a key factor. The current economic momentum is strong, as reflected by the stronger-than-expected December non-farm payroll data (+256,000 jobs created vs. consensus of 165,000) and an increase in job openings. The Atlanta Fed’s GDPNow forecast estimates GDP growth at 2.7%, allowing the Fed more flexibility to be patient with rate cuts. In the December Federal Open Market Committee Summary of Economic Projections, the Fed raised its headline consumption deflator inflation forecast for 2025 from 2.1% to 2.5%, indicating slower progress in returning inflation to its 2% target. Consequently, instead of forecasting a total of 100 basis points (bps) cut in 2025 as per its September forecast, the committee is now considering only a 50 bps cut.
Additionally, several policy proposals from the incoming administration, such as potential tariff increases and immigration restrictions, could introduce uncertainties regarding future inflation. We expect U.S. Treasury yields have already factored in the TCJA extension. Future movements are likely to be influenced by President Trump's initial policies, whether through executive orders or the legislative process.
In the UK, inflation, including wage growth and core inflation, remains persistent. The recent Budget by the Labour government raised National Insurance Contributions for employers, which many firms have indicated they will pass on to consumers through higher prices. Meanwhile, there is no clear path to addressing the fiscal shortfall and boosting long-term productivity growth.
In continental Europe, political uncertainty is a concern, even though underlying inflation momentum is easing. In December, former French Prime Minister Michel Barnier was ousted by a vote of no confidence in parliament as he attempted to push through a budget with tax hikes and spending cuts to address the country’s fiscal deficits. The new Prime Minister, Francois Bayrou, will need to negotiate with the left and far right to gain enough support to pass the 2025 Budget and pension reforms. In Germany, Chancellor Olaf Scholz dismissed his finance minister and coalition partner, Christian Lindner, in December, leading to a call for general elections on February 23. Given the weak growth momentum of the German economy and the challenges facing its manufacturing sector, especially the auto industry, there may be voter demand for the government to be more active in deploying fiscal policy to support growth. Opinion polls indicate that voters want higher minimum wages, more state investments and the introduction of tax deductions for overtime pay. Overall, high bond yields seem to reflect expectations that deficits will rise under the new government to shore up popular support.
Investment implications
While unique political and economic circumstances in individual economies are driving bond yields higher, investors are increasingly focused on fiscal sustainability. The risk of U.S. Treasury yields remaining elevated is higher than in Europe. The U.S. has a stronger economic backdrop than Europe and less uncertainty about leadership in the medium term, at least until the 2026 mid-term elections. This suggests that the European Central Bank may need to act more decisively than the Fed in cutting rates to protect growth, potentially lending more positive momentum to the euro area government bond market than to U.S. Treasuries. This could continue to support a short-duration bias for U.S. Treasuries, allowing investors to take advantage of decent yields without excessive exposure to duration. However, U.S. dollar-based investors should also consider USD strength given the interest rate differential.