G7 BOND YIELDS ARE BREAKING HIGHER INTO 2026 / MACLEOD FINANCE

G7 bond yields are breaking higher into 2026

In this article we demonstrate the consequences of a bond bear market while equities are in in a bubble. Something will have to give and it will be equities.

ALASDAIR MACLEOD

Introduction

Bond markets of three G7 nations are on the verge of crashing. 

The USA, UK, and Canada are not far behind, and the jury is out for Italy. 

But with Japan and two Eurozone nations facing a debt crisis, they are almost certain to take down the other G7s as well.

The most important of the crash candidates is Japan, because low yields for JGBs have encouraged Japanese pension funds and insurance companies to invest in US Treasuries instead. 

Furthermore, the Bank of Japan’s interest rate suppression has given Japanese institutions an additional benefit from a weakening yen to the dollar, moving from ¥103 in late-December 2020 to ¥158 currently, a profitable decline of 35%.

Japanese institutions now account for $1.2 trillion of US Treasuries. 

Mostly by way of a yen-based carry trade, US captive insurance companies and offshore hedge funds based in the Cayman Islands account for an additional $418.5 billion.

Additionally, special purpose vehicles operating out of Luxembourg account for most of an additional $419 billion, and London-based carry traders funding in cheap euros probably represent the bulk of an additional $878 billion. 

Belgium, where Euroclear is based accounts for an additional $468 billion of US Treasuries.

That is a total of $3,383.5 billion of US Treasuries mostly owned by speculative foreign-based “shadow banks” basing their ownership on yield differentials between the US and Japan and the Eurozone. 

It is locking in US Treasury yields to those of sovereign bonds in the euro and yen. 

Where they go, so will US Treasuries.

The charts below are of 10-year bond yields for Japan, Germany, and France. 

Japan’s yield is already in runaway mode, soaring over 2% — the highest level since 1997. 

German and French 10-year bond yields are just breaking into new high ground.

Canada and Italy have similar consolidation patterns but are not yet challenging breakout levels. 

The US 10-year Treasury note is crawling along the lower trend line of a similar pattern to that of the 10-year gilt (not shown):

While the US Treasury yield is not yet threatening to break out above an 18-month consolidation, the global trend is clear. 

And Canada’s is breaking above its flag, but has about 60 basis points to go before making new high ground:

Confirmation of these yield trends is likely to come very soon, though Japan is already leading the way. 

But it is worth noting that longer-dated bond yields in Japan, Germany, and France are already hitting new highs. 

And in all the G7 the longer the maturity, the greater the yield.

The reasons driving higher yields

An investor will want a return on his investment, comprised of his estimate of the following three considerations: the loss of use of capital which might be deployed elsewhere, counterparty risk, and the risk associated with the currency. 

When it comes to investing in readily marketable government bonds in its own currency, it is currency risk which predominates — the risk that at the end of a period, perhaps a year for reference, the currency’s purchasing power might decline.

Therefore, key G7 yields threatening to rise further tell us that the balance of probabilities is for an increasing risk of currencies facing a decline in purchasing power. 

This is confirmed by a rising gold price.

The relationship between bonds and equities

Experience guides us of the relationship between equities and bonds. 

In the first phase of a bull market after the preceding bear, bond yields will have stabilised. 

But the economy is depressed and the bankruptcy rate remains high. 

Seasoned entrepreneurs and company doctors will seek out opportunities to restructure businesses, perhaps merging them with others. 

They will work with banks to recover their loans. 

Gradually, investment and commercial banks will extend finance to facilitate mergers and takeovers. 

Share prices begin an initial recovery process on the back of this corporate activity, but the investing public remains sellers on balance while observing that the economy is still in recession.

Because the expansion of bank credit is limited to financing takeovers, mergers, and other restructuring activities, there is likely to be a pause in the bull market while uncertainty persists, before the second bull phase gets under way.

As increasing signs that the recession is getting no worse and some economic stability is returning, a second bull phase starts. 

Banks gradually become more confident in their lending, perhaps competing for low-risk loan quality by reducing their lending margins. 

Professional investors are early buyers of equities in this second phase, and economic recovery encourages both credit demand and investment. 

Towards the end of the second phase demand begins to drive bank credit expansion, wholesale and consumer prices begin to rise, and interest rates and bond yields begin to rise as well.

In the third and final bull market phase, the wider public reckons buying stocks is a good thing. 

They have forgotten their losses in the last bear market, are always late to the party, and chase fashionable sectors. 

Increasingly, value takes a back seat and momentum investing emerges. 

Greed for profit replaces fear of loss. 

Meanwhile, demand for credit increases, not only to finance unexpected rises in business input costs and excess consumption, but also stockmarket speculation. 

Consequently, interest rates and bond yields rise, due to excessive credit demand in conditions of economic overheating.

This description of the three phases of a bull market separated by two periods of consolidation is an idealised model, shorn of most government meddling. 

But it is important to appreciate that equities can tolerate an initial rise in bond yields — after all they are an alternative investment and their initial decline chases funds into equities. 

But it is the second rise in bond yields which marks the end of the entire bullish cycle.

That is why the charts of government bond yields in the first part of this article are so important. 

While global bond yields have been in a consolidation phase for the last eighteen months, equity markets in the G7 nations rose strongly, as the investing public have come to believe that equities will continue to rise and rise. 

Obviously, the surprise of higher bond yields will shatter that dream.

Equity valuations have become massively overstretched

Our last chart shows something else. 

While we can understand an idealised equity relationship to bonds over one whole cycle, there is a tendency for an even larger cycle to evolve, driven by governments and their central banks preventing the full malinvestment liquidation phase of bear markets. 

Instead of Schumpeter’s creative destruction when accumulated economic distortions are washed out of the system, it becomes only a partial flush, with industrial and financial businesses which should have ceased trading subsidised by governments to continue.

The chart above bears close examination. 

It is constructed by basing the S&P and the long bond yield at 100 in 1985, and plotting both to logarithmic scales. 

While the S&P’s y-axis on the left increases positively, the bond yield’s y-axis on the right is inverted. 

The chart therefore shows the close negative correlation between the two: in other words, a falling bond yield generally correlates with rising equities and vice-versa.

There have been instances when optimism in equities has driven them too high in relation to the bond yield. 

The buildup in the late 1990s to the dot-com bubble is clearly demonstrated. 

A secondary equity overvaluation ahead of the Lehman crisis, corrected by a bear market taking the S&P down to a low point in February 2009 is also visible.

Following that crisis, the Fed suppressed interest rates and therefore bond yields making equities appear cheap relative to bonds, evidenced by the blue line being consistently above the red line on the chart. 

This reached a maximum distortion during covid, when accelerated QE by the Fed drove down bond yields to their lowest level ever. 

That kick-started a new bull phase for the S&P which took it from under 2,500 to 6,834 currently, a rise of 173%.

At the same time bond yields began to recover sharply, reflecting the inflationary consequences of the Fed’s unprecedented QE. 

But so ingrained was end-of-cycle investor optimism that the equity bull has continued to the point where the valuation gap is the largest recorded in history, indicated by the double-headed arrow on the right of the chart.

It is evidence of the end of a super-cycle. 

Over repeated boom-and-bust cycles, government intervention has prevented bust phases from occurring. 

Unaddressed economic distortions have accumulated into a mountain of unproductive debt, as governments have bailed and subsidised economic activities since the 1980s. 

Otherwise, they would have gone to the wall. 

These distortions have fostered an assumption that if things go wrong, the government will always bail everyone out.

Confidence and wealth generation in the stock market are an essential component of economic policy. 

It leads to the conclusion that not just banks and industries will never be allowed to fail, but that the entire financial system including investors will be bailed out as well. 

After all, that was the clear message from the Fed’s handling of the 2007—2009 financial crisis.

Now that bond yields are beginning to rise again with signs of debt traps and doom loops being sprung on governments, the moment when the equity bubble bursts will shortly be upon us. 

Valuations are now so extreme that the collapse in equity values should be greater than anything seen since the 1929—1932 bear market on Wall Street, when 10,000 banks failed.

This time, the economic imperative is to prevent such an outcome. 

Ninety-five years ago, the dollar was on a gold standard: this time it is pure fiat and there is no such restraint. 

We can be certain that the US Treasury and the Fed will use that freedom to expand QE as much as required to secure the entire financial system and prevent a wealth-destroying 90% equity market crash.

They might succeed, but the cost will be the debasement of the dollar. 

It is an outcome already telegraphed by rising gold and metals prices. 

The surprise to all will be sharply rising prices for commodities, goods, and services perhaps from mid-2026 onwards. 

It won’t be prices rising, but the dollar’s purchasing power collapsing.

The signs are that the crisis is at hand. 

Multi-year suppression of commodity prices is backfiring, with silver and platinum threatening to destabilise derivative markets. 

And importantly, the rise in global bond yields is just beginning, threatening to burst the equity bubble. 

And the rise in the gold price is discounting the consequences for all the major currencies in 2026—2027.