Why do long-term interest rates rise while short-term interest rates remain stable in the global bond market?

In recent years, the global bond market has experienced significant Fluctuation, particularly the rise in long-term bond Intrerest Rate has triggered widespread follow. However, this rise does not signify a major shift in inflation expectations, fiscal deficits, or the Liquidity of the government bond market as rumored in the market. This article analyzes the bond markets of the United States, Canada, and Germany, combining specific data to explore the phenomenon of rising long-term Intrerest Rate and stable short-term Intrerest Rate, revealing the driving factors behind the steepening yield curve and its reflection on the macroeconomic fundamentals.

1. The Rise of Long-term Bond Interest Rates: Market Misinterpretation and Reality

Recently, long-term yields in the world's major bond markets have risen significantly. In the US, for example, the 10-year Treasury yield climbed from 4.38% on March 27, 2025 to 4.59%-4.60% on May 23, an increase of about 21-22 basis points. The change may seem significant, but the magnitude is not unusually dramatic. However, the market has widely attributed this phenomenon to concerns about the US fiscal deficit, inflation expectations or liquidity in the Treasury market. This explanation, while common, lacks sufficient basis. Historically, similar arguments have been made many times, but few have been confirmed by data. For example, in December 2023 and December 2024, markets similarly blamed deficits or inflation for the rise in 10-year Treasury yields, but ultimately proved that these concerns were overblown.

Short-term interest rates have not risen in tandem with long-term interest rates. The yield on the 2-year Treasury note rose only slightly from 3.97% to about 4.00% over the same period, almost holding it stable. This divergence between long-term and short-term interest rates is not limited to the U.S. Treasury market, but is also evident in the Canadian and German bond markets. Canada's 10-year bond yield reached its highest level since mid-January 2025 at around 3.65%, while the 2-year yield only edged up to 3.20%. Germany's 10-year Bunds yield recovered to 2.60%, while the 2-year yield (Schatz) held below 2.00%. This global bull steepening of the yield curve suggests that rising long-term interest rates are not a single market or country problem, but a common dynamic facing global bond markets.

2. Factors Driving the Steepening of the Yield Curve

The steepening of the yield curve is an important feature of the current global bond market. The so-called "bull steepening" refers to the fact that long-term interest rates are rising faster than short-term interest rates, leading to an increase in the slope of the yield curve. This phenomenon is often associated with market reassessment of future economic growth and inflation expectations, but is also significantly affected by central bank policy uncertainty.

1. Institutional inflation bias of central banks

The policy actions of central banks are an important factor affecting the bond market. The Federal Reserve, the Bank of Canada, and the European Central Bank (ECB) generally exhibit an institutional bias towards inflation when formulating monetary policy. This bias can be traced back to the 1970s, particularly during the tenure of former Federal Reserve Chairman Arthur Burns, when the theory of inflation expectations was developed. This theory posits that inflation partly stems from the psychological expectations of consumers and markets, and therefore central banks tend to prioritize preventing inflation risks when data does not clearly indicate economic weakness.

Taking the Federal Reserve as an example, market analysis on March 28, 2025, shows that the Federal Reserve's concerns about inflation have led to its "hesitation" on the short-term interest rate path. This uncertainty stems from the Federal Reserve's worries that tariffs may push up prices. Although Federal Reserve officials have publicly stated that the impact of tariffs on consumer prices may be temporary, the experience of "transitory inflation" in 2021 has made them lack confidence in similar judgments. Recent data has further exacerbated this uncertainty. For example, in May 2025, Canada's core CPI rose 2.9% year-on-year, higher than the market expectation of 2.7%; the UK CPI rose 2.3% year-on-year, exceeding the expected 2.1%. This data reinforces the central bank's vigilance regarding inflation and raises the uncertainty premium on long-term bond yields.

2. The stability of short-term interest rates and fundamentals

Compared to the fluctuation of long-term interest rates, the stability of short-term interest rates reflects the market's pricing of macroeconomic fundamentals. The 2-year Treasury yield is more sensitive to economic fundamentals, especially in the context of a steepening bull market. The market expects that if economic weakness intensifies, the downside potential for short-term interest rates will be greater than that for long-term interest rates, making the 2-year bond the focus of investors.

For example, in the first quarter of 2025, while U.S. retail sales data was strong in March (up 4.0% year-over-year), the U.S. Census Bureau's benchmark revisions showed that consumer spending over the past few years was overestimated by about 2%. In addition, Target's May 2025 financial report shows that the number of its physical stores and online shoppers has decreased, and the average amount spent per capita has decreased. This is in line with signs of weakness in the labor market. The U.S. Bureau of Labor Statistics (BLS) Business Employment Dynamics (BDM) data shows that the U.S. labor market has shown signs of stagnation in 2024, and the revised data for new jobs continues to be revised downward, with the nonfarm payrolls report for the first quarter of 2025 averaging -65,000 per month. These data suggest that economic fundamentals are weaker than the market expects, and the stability of the 2-year Treasury yield reflects the market's pricing in a slowdown in the economy.

3. Synchronization of the Global Bond Market

The phenomenon of rising long-term interest rates and stable short-term interest rates is not unique to the United States. In Canada, the rise in 10-year bond yields contrasted sharply with the relative stability of 2-year yields, with the yield curve slope increasing from 0.35 in March 2025 to 0.45 in May. The same was true for the German market, where the yield spread between the 10-year Bunds and the 2-year Schatz widened from 0.50 in February to 0.60 in May. This global synchronicity suggests that the drivers go beyond the fiscal or monetary policies of a single country and are closely linked to the global macroeconomy and the collective behavior of central banks.

3. Historical Perspective: Why the Market Misinterprets Long-Term Interest Rates

Historically, the rise of long-term bond yields has often been interpreted as the market's concern over deficits or inflation, but these interpretations have often been proven wrong. For example:

• 1994-1995: The Federal Reserve raised interest rates due to nonexistent inflation risks, causing the 10-year Treasury yield to briefly surge to 8.0%, but subsequently, the economy did not experience significant inflation.
• 1999-2000: Greenspan raised interest rates due to inflation concerns during the internet bubble, with the 10-year yield rising to 6.5%, but the economy subsequently entered a recession triggered by the burst of the internet bubble.
• 2008: The surge in oil prices (Brent crude oil prices rose from $70 per barrel in 2007 to $140 per barrel in 2008) caused the Federal Reserve to worry about inflation and pause interest rate cuts. However, the collapse of Lehman Brothers and AIG forced the Federal Reserve to restart significant rate cuts in September 2008, lowering the federal funds rate from 2.0% to 0.25%.

The situation in December 2023 and 2024 is similar. The 10-year Treasury yield rose to 4.70% and 4.50% respectively, attributed by the market to deficit concerns and the Federal Reserve's "higher for longer" policy. However, the stability of the 2-year yield (about 4.8% in July 2023 and about 4.3% in November 2024) indicates that the market's judgment on economic fundamentals has not fundamentally changed. Currently, data for 2025 further corroborates this: the rise in long-term interest rates is more a reflection of uncertainty in central bank policy rather than a direct result of deficits or inflation.

4. The Bull Market Becomes Steeper and Market Strategies

Against the backdrop of a steepening bull market, 2-year bonds have become the focus of market investments due to their sensitivity to economic fundamentals and potential downward space for yield. In contrast, 10-year bonds have become an outlet for uncertainty, with their yield fluctuations reflecting the central bank's policy hesitations. For example, from March to May 2025, the rise in 10-year government bond yields was accompanied by fluctuations in the stock market (the S&P 500 index fell 2.5% in April), while the stability of 2-year yields indicated that the market's expectations for an economic slowdown remained unchanged.

In terms of market strategy, investors tend to prefer holding 2-year bonds because, under expectations of economic weakness, the capital gain potential of short-term bonds is greater. Historical data shows that during periods of steepening bull markets, the yield decline of 2-year government bonds is usually 2-3 times that of long-term bonds. For example, during the 2008 financial crisis, the yield on 2-year government bonds fell from 4.5% in 2007 to 0.8% in 2009, while the 10-year yield only decreased from 4.0% to 3.2%.

5. Conclusion

The current dynamics of the global bond market indicate that the rise in long-term bond yields is not a direct result of deficits or inflation expectations, but rather a composite effect of central bank policy uncertainty and a steepening bull market. The inflation biases of the Federal Reserve, the Bank of Canada, and the European Central Bank have led to ambiguity in market expectations regarding the path of short-term interest rates, which has pushed up the uncertainty premium for long-term bond yields. At the same time, the stability of the 2-year bond yields reflects the market's rational pricing of economic fundamentals, including signs of a weak labor market and reduced consumer spending.

Investors should follow the dynamics of 2-year bonds, as they more accurately reflect macroeconomic and monetary fundamentals. While the fluctuation of long-term bond yields is striking, it is more a result of the central bank's "indecision" rather than a fundamental change in economic fundamentals. In the future, close attention should be paid to employment, retail sales, and inflation data to assess whether the economy is slowing further and whether the central bank will adjust its policy direction as a result.