Why rising bond yields could spell trouble for stock markets

By James Yardley on 8 September 2026 in Fixed income

Good economic news would normally be expected to give stock markets a boost. Yet when the US reported bumper jobs figures last week, shares fell.

Why? Because investors are increasingly worried that a strong economy, combined with stubborn inflation, could keep interest rates higher for longer or even force central banks to raise them again. And those fears are showing up most clearly in the bond market.

This matters even if you never intend to own a government bond. Rising bond yields can eventually mean higher borrowing costs for governments, businesses and households. Mortgages and business loans become more expensive, companies have less money to invest and consumers have less money to spend.

And that can become a problem for stock markets.

First, what exactly is happening to bonds?

Governments regularly borrow money by issuing bonds. Investors effectively lend money to the government and receive interest in return.

When investors become more nervous about lending, perhaps because they are worried about inflation or whether governments are borrowing too much, they may demand a higher return for taking that risk. That pushes bond yields higher.

We are seeing that happen across the world.

In the US, the yield on 30-year government bonds has risen from 4.6% in late February to as high as 5.3% in recent weeks, while the 2-year yield has climbed from 3.4% to more than 4.4%*.

But this isn’t just an American problem. Longer-term government borrowing costs have also been rising in the UK, Japan and France. Across the G7 group of developed economies, average government bond yields have reached their highest level since 2000.

There are two big reasons investors are demanding more.

Problem one: inflation isn’t going away easily

Inflation has been above the Federal Reserve target of 2% since February 2021. More recently, higher energy prices have added another complication. But oil isn’t the only issue.

“On the demand side, the substantial AI capital spending is also contributing to inflationary pressures. We expect these dynamics will keep inflation and bond yields elevated.”

Problem two: governments have borrowed a lot of money

The other concern is simply the sheer amount governments need to borrow. Government debt has risen significantly across many developed economies. The more debt governments issue, the more they need investors to keep buying it. But investors don’t have to accept whatever return is offered.

Gareth Gettinby, from the fixed income team at Aegon Asset Management, which runs the Aegon Strategic Bond fund, points to the phenomenon of fiscal dominance, whereby central banks struggle to tackle inflation because of government debt burdens: “In a world of ever-higher debt burdens, governments are becoming increasingly sensitive to borrowing costs, limiting how far central banks can tighten policy without creating wider strains for public finances.”

This creates an uncomfortable problem. Governments need to borrow, but investors may demand higher yields to lend to heavily indebted countries. Those higher yields then make the government’s existing debt burden even more expensive to manage. And because many major economies face the same problem, there may not be a simple solution.

Why can’t governments just push yields back down?

The US has already tried to calm its bond market. Treasury Secretary Scott Bessent announced an expansion of government purchases of longer-term US bonds in August, officially to improve the functioning of the market. Initially, yields fell. But the effect didn’t last.

Could this be solved with some warm words on fiscal responsibility and token spending cuts? Or perhaps some resolution to the war in Iran? This would help, but there are two key problems.

The first is that the problem is global. There is too much government debt and bond markets may be reaching the end of their capacity to absorb it. Individual governments may not be able to make a significant difference.

The second is that the US shows no inclination to deal with its fiscal challenges in a serious way. As Irvine says, fiddling about in the bond market does little to change the fundamentals of US long-term debt — “bond markets are entirely rational, pushing up the risk premium”.

This is bad news for other countries trying to tackle their borrowing costs. In the UK, Chancellor John Healey can’t be sure that sticking to the fiscal rules in his October budget will make a difference to bond yields in the way that previous chancellors could. He can only hope that the UK looks less ugly than some of its peers.

Does this mean interest rates are definitely going higher?

Not necessarily. There are some who take a more optimistic view on inflation, at least in the short term. Dickie Hodges, manager of the Nomura Global Dynamic Bond fund, says:

However, he admits that increasing public debt levels across most advanced economies warrants higher yields. “We continue to see more attractive opportunities in selected emerging market sovereign bonds, where yields remain compelling and fiscal positions are, in many cases, considerably stronger.”

So why should stock market investors care?

This is where bonds become important for anyone invested in shares. Higher bond yields ultimately mean money becomes more expensive.

A company wanting to borrow to build a factory, buy equipment or invest in new technology may have to pay more interest. A household refinancing a mortgage may have less disposable income afterwards. A government spending more on interest payments has less room to spend elsewhere.

All of that can slow the economy and squeeze company profits.

There is also another problem for shares. If relatively low-risk government bonds suddenly offer investors attractive returns, shares have to work harder to justify the additional risk of owning them. That could be particularly important for the AI boom.

Technology companies are spending extraordinary amounts building data centres, buying chips and developing AI infrastructure. Some of that investment is being financed with debt. If borrowing becomes more expensive, companies may eventually have to rethink how much they are willing, or able, to spend.

To date, equity markets have remained relatively sanguine in the face of rising bond yields, but higher borrowing costs will ultimately start to weigh on company margins and spending plans. A resolution to the war in Iran or lower energy prices could ease some of the immediate inflation pressure. But the bigger problem – governments carrying large debts while investors demand increasingly attractive returns to finance them – will be much harder to solve.

For investors, that means the next threat to the stock market may not necessarily begin in the stock market at all. It could start with the rising cost of borrowing in the bond market.

*Source: MarketWatch, as at 8 September 2026