Bonds face a bigger threat than the Fed as global rates climb

As investors debate whether and when the Federal Reserve will raise interest rates, market expectations for further tightening are building around the world — and spelling trouble for bonds.

Traders see borrowing costs rising faster in Japan, Canada, the euro zone and the UK than in the US over the next year. Of the 32 swap markets tracked by Bloomberg, two-thirds are priced for rate hikes, with South Korea leading the pack at more than 100 basis points.

It marks a shift from the Fed-dominated rate cycle of recent years. This time, central banks are facing overlapping pressures from higher oil prices from the Iran war, heavy government spending and an AI investment boom that’s supercharging growth. Inflation across countries in the Organisation for Economic Co-operation and Development recently hit a two-year high.

That leaves investors with an uncomfortable prospect: bonds are supposed to cushion portfolios when things go wrong — for example, if the AI-driven stock rally reverses or another trade war hits growth. If central banks outside the US are forced to tighten more aggressively, those bonds could instead add to losses, undermining one of the foundations of traditional diversification.