Volatility in bond markets – what’s next for yields and interest rates?

Why have bond markets been so volatile?

It has been quite a turbulent start for markets in 2025. There has been a rally over the past week or so in gilts and in the US treasuries, but that's been following a very aggressive sell off at the beginning of 2025.

At the beginning of the year, markets seemed very concerned about fiscal policy and inflation. In the US, concern around tariffs and unfunded tax cuts (which could potentially be inflationary) led investors to be concerned about higher rates for longer, causing a selloff in US treasuries, with the 10-year US treasury reaching nearly 5%.

In addition to this, we had strong US employment data, lowering the chance of multiple rate cuts from the Fed over the coming year.

What about UK government bonds?

In the UK, we saw similar moves in government bond markets, as gilts moved sold off more than their US counterparts. The UK 10-year gilt reached levels that we've not seen in nearly two decades.

The sell off was partially driven by concerns around sticky inflation and challenges to UK fiscal policy. This created an unusual ‘doom loop’ situation whereby rising gilt yields led to an increase in UK government borrowing costs. This led to more pressure on already fragile public financing, adding cause for concern over the UK economy.

On a more positive note, we did have encouraging inflation data last week. UK CPI was below expectations in the 12 months up to November. US inflation also came in below market expectations. Diving into the detail of the numbers, services inflation, which the Bank of England (BoE) pay particularly close attention to, came in under expectations.

In addition, we had weak GDP growth numbers last week in the UK. That gives the BoE a little bit of ammunition to cut rates at the next meeting in February.

Since the US election and UK Autumn Budget, there's a lot of fear in gilt and US treasury prices. We think that's going to persist for some time off the back of fiscal policy in the US and potentially reaccelerating inflation in the UK.

What is the outlook for bond markets?

There's a lot of negative sentiment prices into bond prices at the moment. This is a good thing in the sense that the room for gilt yields and US Treasury yields to drift higher is limited. That's not to say that they won't, but it’s more likely they’ll move sideways for a little bit. People will be looking at future inflation and employment data to see if central banks (the Fed and the BoE) are able to cut rates. We could see the short end of the yield curve start to come down a little bit more if we get continued weaker inflation data, or if we see a loosening in the job market.

Question marks remain around fiscal policy in the UK and the US. In the US, the question is how extreme Trump will be with his unfunded tax cuts and tariffs. If that is as bad as markets expect, or even worse, then we'll see longer yields sell off a little bit more or at least stay elevated. So, while there is a lot of bad news in bond prices, there aren’t many catalysts for a major bond rally at the moment, unless we see the UK or US fall into a recession.

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Do you see the recent sell-off in yields as a Liz Truss 2.0?

This time is a little bit different. There has been a lot of negative moves in the bond market, but the extent of the sell off hasn't been as bad as what we saw in 2022.

One of the reasons is that fiscal policy is more moderate now than what was proposed in Liz Truss’s mini budget. In addition, the sell off was exacerbated by over-leverage pension funds, a problem which has since been resolved. Finally, inflation at the time was at a record high with no signs of coming down, and as such we were amid an aggressive rate hiking cycle. There isn't any need for central bank intervention at the moment, however investors will likely remain in wait and see mode to see what UK government could do to stop some of the fears in the bond markets.