The shape of yields to come

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At the start of 2025, I said that investors should “beware the long bond”. The good news is that yields on the longest-dated bonds did not run wild during the year. The 30-year Treasury and the 30-year gilt are ending where they began. Yes, the 30-year bund has gone from 2.6% to 3.5%, while the 30-year Japanese Government Bond (JGB) is up from 2.3% to 3.4%. However, this is healthy: a world in which investors were willing to lend money for three decades at incredibly low rates (well under 1% at times in Japan) is very damaged, and higher long-term rates are a step towards normality.

At the same time, we are seeing early hints of an important shift. While longer-term rates are not coming down, the short end of the yield curve is. With the exception of the Bank of Japan, central banks mostly reduced rates in 2025, including cuts by the Bank of England and the US Federal Reserve in December. This is likely to accelerate in 2026 in the US: markets are underestimating how aggressively Donald Trump and whatever thrall he appoints as Fed chair will try to cut rates to juice the economy.

Time for governments to issue more short-term debt

Rate cuts alone do not solve today’s big problem for governments. Central banks directly set the rate at which they lend very short-term money to commercial banks. Expectations for this largely set the path of short-term bond yields, but longer-term yields are determined more independently by markets. So even if short-term rates come down, higher long-term yields will still push up the cost of interest on public debt.

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Whenever a bond issued at miniscule rates a few years ago has to be refinanced, the new rate shoots up. Thus the amount of interest that government pay is steadily rising. They can try to cut spending to bring down debt, but we constantly see that this isn’t politically possible.

The obvious way out is to inflate away debt – but when markets expect higher inflation, they will demand higher yields to compensate, negating the gains from inflation. Central banks could hold down yields by buying up long-term bonds, but a decade of quantitative easing has shown us how much distortion this causes. The best option for now is to cut long-term debt issuance in favour of short-term debt, which pays lower yields. That is what we are seeing in countries including the US, the UK and Japan (that’s why average maturities of outstanding debt are dropping – see chart). However, a flood of short-term debt could unsettle markets and cause yields to rise. Note that earlier this month, the Fed launched a $40 billion programme of buying short-term bonds. It describes this as a technical move to manage market liquidity, but don’t be surprised if this is just the first step in central banks systematically buying short-term bonds.

So here’s a scenario. Governments issue more short-term debt. Central banks a) cut rates below inflation and b) buy more and more short-term bonds to keep yields down. Longer-term yields tick up, and the yield curve gets steeper. How will this affect markets? Is it inflationary? We should start to find out in 2026.

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Cris Sholto Heaton is an investment analyst and writer who has been contributing to MoneyWeek since 2006 and was managing editor of the magazine between 2016 and 2018. He is especially interested in international investing, believing many investors still focus too much on their home markets and that it pays to take advantage of all the opportunities the world offers. He often writes about Asian equities, international income and global asset allocation.

Cris began his career in financial services consultancy at PwC and Lane Clark & Peacock, before an abrupt change of direction into oil, gas and energy at Petroleum Economist and Platts and subsequently into investment research and writing. In addition to his articles for MoneyWeek, he also works with a number of asset managers, consultancies and financial information providers.

He holds the Chartered Financial Analyst designation and the Investment Management Certificate, as well as degrees in finance and mathematics. He has also studied acting, film-making and photography, and strongly suspects that an awareness of what makes a compelling story is just as important for understanding markets as any amount of qualifications.