Key Takeaways
- The yield curve has steepened over the past year, widening the gap between short- and long-term bonds.
- Persistent pressure on long-term rates has limited the ability of duration-based strategies to protect portfolios in the event of a crisis.
- Japan has seen long-term yields spike despite only a modest increase in inflation and interest rates.
Long-term government bond yields in advanced countries have risen over the past year as investors demand a greater premium for buying debt of 10 and 30-year maturities.
This “steepening” in the slope of the yield curve indicates a widening of the spread between short- and long-term government bond interest rates.
This is evident in the chart below, which shows how the slope of the US Treasury yield curve has increased for different maturities since 2025.
Why Have Long-Term Bond Yields Risen?
Although central banks, including the European Central Bank and the US Federal Reserve, cut short-term interest rates in 2025, long-term bond yields did not follow weakening short-term yields. In some cases, they moved in the opposite direction, creating a steeper yield curve. As a result, long-term bonds offer significantly higher yields than shorter-term bonds. As yields move inversely to prices, this shows the effect of investors selling long-dated government debt.
“The reason for this is that investors have started to demand a risk premium for investing in long-term bonds as insurance against inflation risks and against the trajectory of fiscal policy, which is considered too expansionary,” says Nicolò Bragazza, associate portfolio manager at Morningstar Wealth.
Investors have also begun to question whether long-term government bonds, such as 30-year bonds, are suitable for protecting portfolios against market risks and whether it might be better to favor short-term bonds, those with one-to-three years maturities, or medium-term bonds, those with five-to-10 year maturities.
The debate over the potential crisis in long-term government bonds has heated up recently in the face of growing political uncertainty in the UK, the outcome of the elections in Japan, with the landslide victory of Prime Minister Sanae Takaichi’s government coalition, and the process of diversifying investments away from US assets.
Why Duration Matters for Long-Term Government Bonds
Duration is a measure of the sensitivity of a bond to changes interest rates, which increases depending on the maturity of the bond. It reflects the time required for the initial capital invested to be repaid through coupons.
For bond fund managers, owning duration along the yield curve can act as “insurance” when long-term bonds are issued by countries with conservative fiscal policies.
Now developed countries have upgraded their spending plans and investors are worried about the long-term effect on government debt. Increased defense spending and strategic independence in the US and Europe, fiscal policies to support growth in Japan, and structural factors such as population ageing will further increase the debt-to-GDP ratio of developed countries, which had already reached 127% in 2024 from 76% at the beginning of the century.
Laura Cooper, global investment strategist and head of macro credit at Nuveen, says “the advantage of holding long-term rates across the entire G10 [countries] is being called into question” due to expansionary fiscal policies and abundant supply of government bonds.
“Duration has not disappeared, but the conditions under which it fully functions have become more limited, as long-term rates remain under persistent pressure,” she says.
Is the Long-Term Government Bond Crisis Inevitable?
The crisis in long-term bonds is not irreversible, according to experts. Stefano Fiorini, global fixed income fund manager at Generali Asset Management, does not consider the crisis to be “structural” but rather speaks of “an adjustment of yields to a post-Covid reality characterized by higher inflation and structurally larger public deficits.”
The recovery in long-term debt demand needs a “greater clarity on stimulus and fiscal sustainability, less volatility in the US administration’s extraordinary policies, a coordinated reduction in long-term emissions, and a return to the asset class by institutional investors, which is only possible with less volatility and more visibility on economic growth and inflation,” says Andrea Campisi, senior investment manager at Pictet Asset Management.
Japan has been the focus of the debate over long-term bonds because the country’s long-term yields spiked despite only a modest rise in inflation and increase in interest rates to 0.75%. Over the past five years, the yield on 30-year Japanese government bonds has risen from 0.6% to the current 3.5%.
“There are yield levels at which 30-year government bonds will once again attract investors. I don’t think that moment has arrived yet, but I don’t think it’s far off, as most of the repricing seems to be behind us now,” says Fiorini.
Investors Should Beware Dumping Long-Term Debt
With long-term government bonds no longer able to fully fulfill their “insurance” function, short and medium-term maturities are back in vogue. However, Morningstar’s Bragazza warns that short-term bonds would not provide “sufficient balance to equity risk in diversified portfolios in the event of a recession.” He adds that the slope of the curve suggests that investing in shorter-term bonds means giving up extra yield. Investors therefore find themselves in a situation where the middle and long end of the yield curve is more attractive, but also where the greatest risks are concentrated.
Bragazza urges investors “not to exclude medium- and long-term bonds from diversified portfolios,” but reminds them to balance the extra return that can be obtained with these securities against portfolio objectives and the risk of a significant decline in the stock market.
In the Eurozone, Duration Strategies Can Still Work
A crisis in long-term government bonds does not affect all countries in the same way. The yield curve remains subject to volatility and risks of further steepening in the United States, where fiscal stimulus remains ample and fears about inflation and pressure on the Federal Reserve persist. In the United Kingdom, the main variables are political instability and fears over the sustainability of government finances.
The dynamic is different in the eurozone, which has seen interest rates cut from 4% to 2% and inflation undershoot the target.
Nuveen’s Cooper says duration strategies are “more likely to play its role effectively” in the eurozone because “growth risks remain skewed to the downside, inflation expectations are anchored, and the ECB is more likely to react to these dynamics.”
“In a risk-off environment, this increases the likelihood that yields will fall when needed,” says Cooper, who, however, does not rule out that yields could move higher “due to spending dynamics that are creating a structural shift toward higher yield levels.” The current moment, therefore, may not be “the best entry point” for the asset class.
Among eurozone government bonds, extending duration along the German bund curve as a hedge against risk “is unlikely to work as it has in the past,” Nuveen’s Cooper says. As for Italy, however, opinions are mixed, despite the successful placement of a 15-year BTP in early February, with demand 11.2 times higher than the EUR 14 billion issued. The Nuveen strategist says she prefers “long-term credit exposures in Italy over rates,” that is corporate bonds, while Fiorini of Generali Asset Management considers current Italian bond yields “attractive to the market,” thanks in part to the narrowing of spreads relative to German bunds.
