BlackRock sounds alarm on long-term U.S. bonds as debt sustainability concerns drive yield surge

American investment major BlackRock said it is doubling down on its underweight stance on long-term U.S. government bonds, issuing a warning that investors are now demanding significantly higher compensation for the risks associated with holding them.

In its latest market commentary, the world’s largest asset manager pointed out that rising term premiums mark a return to historical norms, a factor it has anticipated for a while.

“Investors now want more compensation for the risk of holding long-term [U.S.] bonds,” BlackRock wrote, framing the surge in yields since April as a long-awaited correction to ultra-low-interest rate expectations that were “lulled” into place during the pandemic.

Explaining the point further, the investment firm argued that during the pandemic, ultra-low interest rates pulled investors into a sense of safety over ballooning U.S. debt. “Ultra-low interest rates in the pandemic lulled investors into a sense of safety about ballooning government debt. They accepted lower-term premium, or compensation for the risk of holding that debt over a long time. That pulled down global yields as well,” the report said.

The 10-year U.S. Treasury yield edged lower to 4.40% last week but remains 50 basis points above its April trough. According to BlackRock, this is because of growing fiscal concerns and a renewed focus on the long-term sustainability of U.S. debt.

“Policy developments, like the budget bill, draw focus to U.S. debt sustainability. This has revived questions about the diversification role of Treasuries,” it said.

The firm estimated in March that the U.S. deficit-to-GDP ratio could hit 5% to 7%, a figure now potentially “pushed to the upper end of that range – or beyond” given recent congressional proposals. “We maintain our strongest conviction: staying underweight long-term U.S. Treasuries,” BlackRock asserted.

A potential rise in the term premium could also impact foreign investor behaviour, the firm cautioned. “We’re watching to see if these changes impact foreign investors and drive term premium even higher.”

The outlook isn’t much better in Japan. BlackRock noted that 30-year Japanese government bond yields hit a record high in May, triggering the weakest auction demand in a decade and prompting the Finance Ministry to consider trimming issuance. “If yields rise more, the government’s cost to service its debt – now twice the size of its economy – will also rise,” the report warned.

Even as bond markets wobble, BlackRock sees relative opportunity in the Euro area and Japan.

“We’re still underweight long-term developed market government bonds but have a relative preference for the euro area and Japan over the U.S.,” it said, pointing to the European Central Bank’s capacity to cut rates amid a sluggish economy and rising investment in infrastructure and defense.

On equities, the firm remains resolutely pro-risk, especially in U.S. tech.

“Our U.S. equity overweight is grounded in the artificial intelligence mega force – reinforced by Nvidia’s earnings beat last week,” BlackRock said. The S&P 500 rose nearly 2% last week, led by tech names, and is now up almost 22% from April lows.

BlackRock also cited “hard economic rules” as a stabilising force in U.S. policy, noting how dependencies—like foreign capital funding U.S. debt—limit drastic deviations from the status quo. “We flipped back to being pro-risk in April once it became clear that hard economic rules limit how far U.S. policy can move,” the report said.

Strategically, the firm prefers short-term bonds, euro area credit, and private credit over long-term Treasuries. “We prefer short-term inflation-linked bonds over nominal developed market government bonds, as U.S. tariffs could push up inflation,” it added.

Bottom line, according to BlackRock: “U.S. Treasury yields have jumped since April. That’s a global story of normalising term premium. We stay underweight long-term DM government bonds, preferring shorter-term bonds and euro area credit.”

BlackRock isn’t the only investment major to warn over the wobbling U.S. bond market. A day before, JPMorgan Chase’ firebrand CEO, Jamie Dimon, in a public engagement, pointed out that U.S. markets, and especially the bond market, could be heading towards turbulence. He even warned that a ‘breakdown’ in the bond market could be in the offing, which could catch regulators off guard.