analysis
‘Very big structural forces’ pushing bond markets to the brink and interest rates higherBy business correspondent David Taylor
Posted Tue 8 Sep 2026 at 4:44amTue 8 Sep 2026 at 4:44amTue 8 Sep 2026 at 4:44am
Inflation in Australia and across the globe is not falling as hoped and it’s raising serious concerns for the economy and asset prices.
If inflation remains stubbornly elevated, interest rates will need to either rise or at least stay uncomfortably high for borrowers.
If they rise, asset prices, including property and shares, will have nowhere to go but down and the Australian economy risks falling into a recession.
We already have a window into this world, via the bond market, and it’s looking rather dark.
The bond market measures how much risk is attached to an IOU. The higher the interest rate, the greater the probability money will go missing in action after being borrowed, either through default or erosion by inflation.
The interest rate on the Australian 10-year government bond is near a 15-year high, and the risk is it could move higher.
Rates on 10-year US government bonds are the highest they’ve been since the onset of the global financial crisis.
Investors are increasingly cautious about lending money to once seemingly infallible borrowers, like large Western governments.
The anxiety around credit is putting enormous pressure on financial markets and the economy, and the risk is that it will worsen.
Losing faith in the US
Author and former banker Satyajit Das describes the US economy as the critical “stress point” for the global bond market.
Major financial players are already stepping back from their once considerable exposure to the US.
It was recently revealed that the Reserve Bank (RBA) reduced its holdings of US dollars (in its foreign reserves portfolio) by 10 per cent in 2025, taking it back to 2012 levels.
Deutsche Bank’s macro strategist, and former Reserve Bank economist, Lachlan Dynan, said the investment bank was bringing “it to light now as fresh questions are asked on whether US dollar reserves and Treasuries have lost some of their previously exceptional appeal, and especially more recently as a strained US fiscal position has led to some concerning signals on the usability of US dollar reserves for intervention purposes.”
Then, late last week, the central bank of the Netherlands said it had moved dozens of tonnes of its gold out of the United States and Canada.
The De Nederlandsche Bank (DNB) said in a statement the removal aimed to boost the country’s “crisis preparedness” amid “increasing geopolitical unrest”.
And the manager of Norway’s $US2.3 trillion sovereign wealth fund has proposed reducing its exposure to US Treasuries.
The manager of the fund, Norges Bank Investment Management, is now looking at reducing its investment in government debt from 70 per cent to 50 per cent of its total bond holdings, with US Treasuries getting the biggest cut.
China, Brazil, India and Japan have also reduced their investment exposure to a potential US economic mishap by cutting their investments in US government bonds.
But the US is far from alone.
Das adds France, Italy, Britain and Japan to the list of nations teetering on the edge of crisis, given they are “all heavily indebted countries with stagnant economies and very deep structural [economic] problems and in some cases with growing political strains, and their credit quality is going down”.
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Mounting pressure on bond yields
It’s only adding to an already-in-train bond market rout that is pushing interest rates higher.
The interest rate on a bond moves inversely to its price, so as the price of a bond falls, the yield, or interest return from it, rises.
The catalyst for the latest sell-down was US Treasury Secretary Scott Bessent’s announcement in August that he would at least double the US Treasury’s repurchase of bonds with maturities between 10 and 30 years to $US4 billion.
By buying so-called long-dated bonds the US government was proactively trying to lower the interest rate on them and, by extension, long term interest rates in the US, to which most mortgages there are tied.
Interest rates were rising at the time because, shortly before Bessent made the announcement, news arrived that US government debt had reached $US40 trillion, which sparked a bond sell-off.
Ironically, Bessent’s attempt to soothe bond market nerves only added to them.
Since then, military conflict in Iran has also escalated, pushing the price of oil back firmly above $US90 a barrel.
This, says AMP’s chief economist Shane Oliver, has undone any US efforts to artificially lower the interest rate on bonds.
“Unless you get the budget deficit down in the US, in other words improve the fundamentals, any action by the US Treasury is just a temporary stopgap measure,” Dr Oliver said.
“It worked for a few days and then, of course, it’s fizzled out again.”
The only way is up
There is of course another strong current pushing bond yields higher — the once-in-a-generation investment in artificial intelligence (AI).
Big Wall Street tech giants are spending billions of dollars on AI and associated infrastructure like data centres.
After sucking up enormous amounts of equity (asking share investors for money) in recent years, they have moved onto debt (bonds), including private credit.
It’s meant the US government is competing with large tech firms for credit, and it’s pushing the cost of that debt up, or the interest rate on bonds.
The Commonwealth Bank’s head of markets and rate research, Adam Donaldson, sees no end to the upwards pressure on bond yields.
“There are very big structural forces pushing both interest rates and bond yields higher,” he said.
But Donaldson’s other point may send a shiver up the spine of every Australian mortgage borrower.
“The market is sending a very strong message about what cash rates are going to average over time,” he said.
The cash rate is what central banks, including the Reserve Bank, use to set monetary policy, and they heavily influence the cost of Australian variable rate mortgages.
He believes the combination of the “massive boom in AI, defence spending, the net zero carbon economy, various infrastructure requirements, and lack of [general governmental] fiscal discipline” are pushing up what he calls the “neutral rate”.
That is the interest rate most central banks believe will keep inflation contained.
In the US it’s called the “R-Star”, or the theoretical real interest rate that keeps the economy operating at full employment while maintaining stable inflation.
It’s the interest rate sweet spot that keeps economies humming along and anything higher than that, in theory, causes businesses and households financial pain.
It has trended higher in the US from 1.36 per cent (in the first quarter of 2025) to, according to the New York Federal Reserve, 1.65 per cent for the second quarter of 2026.
Critical moment for global economy
CBA’s Adam Donaldson argues confidence and credibility in the US central bank are at the heart of this bond market rout.
Relatively new Federal Reserve chair Kevin Warsh needs to prove to the world economy that he will set monetary policy according to the needs of the economy, not the Trump administration.
If, Donaldson says, those “question marks get louder” about central bank credibility, the “bond market will fall harder”, and interest rates will rise further.
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Satyajit Das points out that 30 per cent of US government debt is owned by foreign financial institutions, governments, and central banks.
“They live on the kindness of strangers,” he says.
“You’re going to see a massive re-jigging of the demand”, he says, for bonds as their risk increases.
All these pressures, Das says, “mean interest rates aren’t likely to go down anytime soon”.
Governments, central banks, major financial institutions, global financial markets, and many millions of mortgage borrowers the world over may not be prepared for that.
Indeed, the key difference between the economic environment now, and other periods that preceded potential financial catastrophe like the European debt crisis and the COVID-19 pandemic, is that inflation is already too high for policy makers’ comfort.
It means lower interest rates and money printing, which can act as a soothing balm for financial markets, may no longer be credible monetary policy tools during the onset of a crisis.
As Das argues, massive Wall Street stock valuations are already “over-stretched”, and as interest rates move up and those assets are heavily repriced down, “essentially that is the process by which all crises start, and that is the trajectory we are on”.
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