Watching global bond markets sell off (yields rise) during the last few months, those with memories of the extreme bond selloffs in the 1970s and 1980s may have asked, “Have the bond vigilantes returned?”. The question refers to the extreme sensitivity bond investors had to government budget deficits and debt some 40-plus years ago and how anything that created government red ink brought a bond selloff that in turn often forced a change in fiscal policies. The answer to the question for 2026 is, yes: to no small extent the vigilantes seemed to have returned, but there is more.
How Far Yields Have Risen in 2026
This year’s selloff, though small compared with the experience of the 1970s and 1980s, is nonetheless significant. Bond prices have fallen enough in the United States so that 10-year treasury bond yields have risen from 4.1% at the end of February to some 5.0% recently, a jump of 90 basis points (hundredths of a percentage point). Yields on the 30-years treasury maturity have risen 70 basis points from 4.7% at the end of February to some 5.4% recently. Dollar-based markets are not alone. In the United Kingdom, the yield on 10-year government gilt bonds has risen some 140 basis points from 4.2% at the end of February to 5.6% recently. Yields on comparable French government bonds have risen some 130 basis points, while yields on similar maturity German, Italian, and Japanese government bonds have risen respectively 90, 110, and 90 basis points.
Government Deficits and Debt Are Driving the Selloff
The bond vigilante contribution to these movements is clear enough. Bond investors across the developed world have become increasingly disturbed by government budget trends. In the United States, for instance, projections of the federal deficit have increased in just the last few months. Originally, the Congressional Budget Office (CBO) set the deficit figure for fiscal 2026 at $1.9 trillion, already slightly higher than the $1.8 trillion recorded in fiscal 2025. Now the CBO says that this year’s deficit will likely be closer to $2.1 trillion, a 10.5% jump from the original estimate and an 18% jump over the actual deficit for 2025. This budget shortfall adds to an outstanding debt load that is already 125% of the nation’s gross domestic product (GDP), up from 106% before the pandemic and dramatically from 54% at the turn of the century.
Nor is the United States the only nation giving cause to would-be bond vigilantes. Westminster’s debt load in the UK stands just below 100% of the country’s GDP, up from about 40% at the turn of the century. For France, the figure has risen during this same time from 60 to 118%. In Italy, the figure has risen from 109 to 138%, while Japan’s debt burden stands at 232%, up from 136% at the turn of the century. Germany is in better shape with outstanding government debt at 64% of GDP, but even that is up from some 59% in 2000.
Why Markets Are Reacting Now
Since these debt pressures have been building for some time, the natural question is why have bond markets waited until now to become so worried. To some extent, the answer lies with what can be described as policy fashion. Frequently, markets will ignore a growing problem until it reaches critical mass or some event calls people’s attention to it—in this case perhaps the need for Europe to spend more on the defense of Ukraine and for the United States to do the same to support the fighting in the Middle East. Alternatively, market participants might have been distracted until recently by other important considerations, such as the pandemic, the recovery from the damage of the lockdowns and quarantines, the implications of the fighting in Gaza, immigration, and other electoral or cultural issues. It is clear now, however, that budgets and debt have captured the market’s attention.
Why Inflation Isn’t the Main Culprit
Inflationary concerns have been identified as a factor in the selloff. This is not unreasonable. The rise in the price of oil and especially gasoline have raised fears about future inflation, and bond yields typically adjust to compensate lenders for how much purchasing power buyers expect to lose on the loan’s nominal amount over its term. Still, important as inflation expectations are, a look at market detail suggests that inflation fears, though present, have played only a small role in the recent selloff.
The indicator on this front emerges from the relative behavior of inflation-adjusted treasury bonds. Because these so-called Treasury Inflation Protected Securities (TIPS) adjust their principal for inflation, their current yield, unlike those on more conventional bonds, does not have to compensate lenders for any expected loss of purchasing power, leaving the gap in yields between TIPS and other bonds a good indicator of inflation expectations. And since that gap has changed little—from 2.4 percentage points on the 10-year maturity last February, before the selloff began, to 2.6 percentage points recently—it would seem that adjustments in inflation expectations have so far played only a small role in the bond selloff.
What the Yield Curve Signals About Fed Policy
This yield gap also offers insight into market expectations on Federal Reserve (Fed) policy. Because this implied inflation expectation is lower than the current inflation rate, market participants would seem to expect that the Fed will successfully re-engage the inflation fight, that is raise short-term interest rates sufficiently to ease inflationary pressures. The shape of the yield curve tells just this story. Last year, when bond investors expected the Fed to disengage from the inflation fight and cut short-term interest rates, bond yields between 7- and 10-years maturity were all lower than short-term rates. That expectation was on the mark. The Fed did just that. Now yields on these longer-dated securities have risen markedly higher than short-term rates, signaling an expectation of short-term interest rate hikes, in other words of such a Fed re-engagement. Indeed, heightened inflation fears might emerge and add to the bond selloff should the Fed fail to raise short rates as expected.
AI Data Center Borrowing Is Adding to the Pressure
There is a fourth consideration in this mélange of influences, one that Fed Chairman Kevin Warsh has emphasized. The growth of artificial intelligence has generated huge borrowing demands by technology firms to build the required and expensive data centers. Especially because these firms otherwise have strong finances, their bond issues compete directly with government debt and could well have raised borrowing demands sufficiently to push up all bond yields, including on longer-term government issues. Since data centers are not going away, this demand for funds is likely to persist and keep yields higher than they otherwise would be.
That would seem to burden the economy, but if, as many expect, AI enhances productivity growth, it could create an economy that can prosper even in the face of higher bond yields and other borrowing costs. Indeed, since interest rates ultimately reflect the general returns investments can earn in an economy, such a sustained elevation in yields could signal economic health.
What This Means for Yields Going Forward
Picking up all these disparate threads, it would seem likely that yields, after this recent runup, will stay at elevated levels for some time to come. Since inflation fears contributed only little to the picture so far, yields will likely remain elevated even if things improve in the Middle East and the oil begins to flow again in sufficient abundance to bring prices down. In the meantime, it is fanciful to expect fiscal discipline any time soon and the needs for huge AI and other technology investments seem likely to last for quite some time yet.
