[Kangkook Lee's column] Long-term interest rates surge… 'Warning' rings for financial markets and the global economy

Dr. Kangkook Lee is Professor of College of Economics at Ritsumeikan University in Japan and Affiliated Research Fellow at CUKPE

Recently, the biggest focus of attention in the international financial market has been interest rates. This is because long-term interest rates in developed countries such as the United States, Japan, and Europe are rising rapidly. Typically, long-term rates rise when demand for funds increases due to expectations of economic improvement, when inflation rises, or when it is anticipated that central banks will raise their benchmark interest rates. Currently, however, long-term rates are rising excessively even relative to inflation expectations, despite the unfavorable economic outlook and low likelihood of a Federal Reserve (Fed) rate hike, raising concerns. As a sharp rise in long-term rates will have a negative impact on financial markets, the world's eyes are focused on the graphs of interest rate fluctuations. Let us examine why long-term rates are rising, what impact they will have, and how each country should respond.

Why are long-term interest rates skyrocketing?

The graph below, showing changes in 30-year government bond yields since the 1990s, demonstrates that interest rates have been surging in developed countries since the 2020 pandemic. On August 18, 2026, the 30-year U.S. Treasury yield reached 5.29%, the highest level since June 2007. Japan also rose to 4.14%, Germany to 3.77%, and South Korea to 4.76%. When government bond yields, which serve as the benchmark for all interest rates in the financial market, rise, other rates such as mortgage interest rates also increase, having a significant impact on people's lives.

Recently, a flood of analyses has emerged regarding these rising interest rates. Fundamentally, higher interest rates mean lower bond prices, and a rise in government bond yields implies that investors are less willing to buy government bonds than before. Inflation becomes a significant factor in raising long-term interest rates, as investors will seek higher returns if prices are expected to rise in the long term. Indeed, inflation has risen since the pandemic, and long-term government bond yields have also increased.

However, the recent rise in government bond yields is steep even when accounting for inflation, and the cause commonly cited is government fiscal issues. As advanced nations face growing fiscal deficits and seek to borrow money, accumulating debt, investors reduce their demand for government bonds out of concern for the fiscal situation. Consequently, bond prices fall and interest rates rise.

Since the pandemic, many developed countries have actively spent fiscal resources to stimulate their economies, leading to increased deficits and debt.  According to the Congressional Budget Office (CBO)’s February U.S. fiscal outlook, the Trump administration’s large-scale tax cuts and increased fiscal spending are projected to result in a fiscal deficit of 5.8% of GDP by 2026, with the ratio of private and external government debt to GDP reaching 100.8%. Furthermore, it is forecasted that an annual fiscal deficit of approximately 6% of GDP will persist over the next 10 years, pushing the government debt ratio to approximately 120% by 2036.

Even in Japan, where the government debt ratio already stands at approximately 200% of GDP, long-term government bond yields are rising as investors continue to turn their backs on them following the inauguration of the Takaichi government, which emphasizes fiscal expansion. The Japanese government recently announced that it will lower the consumption tax on food from 8% to 1% for two years starting next April, which is another factor contributing to the rise in bond yields. This is because the resulting fiscal burden amounts to approximately 10 trillion yen.

In addition to fiscal issues, rising oil prices driven by the war in Iran are fueling inflation and driving up long-term government bond yields. Interestingly, as developed nations expand fiscal spending through subsidies to counter rising oil and electricity prices, the increase in oil prices actually exacerbates fiscal problems.

Another factor driving up long-term interest rates is the issuance of bonds by U.S. Big Tech companies —so-called hyperscalers—leading the artificial intelligence (AI) boom. Capital expenditures (Capex) by the top five hyperscalers—Amazon, Alphabet, Microsoft, Meta, and Oracle—are projected to rise from $379 billion in 2025 to $691 billion in 2026 and $892 billion in 2027; the problem, however, is the massive amount of money required. Consequently, free cash flow—calculated by subtracting capital expenditures from operating cash flow—declined rapidly in 2026. To finance these massive investments, they are now borrowing funds from investors by issuing corporate bonds. This increases the bond supply, lowering bond prices and driving up interest rates.

According to a Reuters report, corporate bond issuance by the top five hyperscalers, including Amazon, is projected to reach $20.1 billion in 2024, $109 billion in 2025, approximately $250 billion this year, and $400 billion in 2027. Furthermore, these corporate bonds are more popular than U.S. government bonds because their interest rates are nearly 1 percentage point higher. In short, as both governments facing poor fiscal conditions and AI companies seek to borrow massive amounts of money amidst inflation, long-term interest rates in the market are rising rapidly.

The shock and response to rising interest rates

Such a sharp rise in long-term interest rates could deliver a major shock to the financial market. Rising interest rates have an overall negative impact on consumption and corporate investment, and can slow down the economy by stagnating the real estate market. In particular, rising interest rates impact the stock prices of growth industries, such as technology and biotech firms, placing downward pressure on the stock market. Indeed, when U.S. Treasury yields surged on August 18, the Nasdaq index fell 1.3%, and the Philadelphia Semiconductor Index dropped by approximately 5%.

Therefore, the U.S. government is deeply concerned about rising long-term interest rates. In fact, when the Trump administration announced tariff hikes last April, it backed down as Treasury bond yields surged. Meanwhile, when the Japanese government intervened in the foreign exchange market on July 30–31 to prevent the yen from weakening, the U.S. also aided the Japanese government by selling euros and buying yen. This is related to concerns that if Japan, the largest holder of U.S. Treasury bonds, were to sell U.S. Treasury bonds to buy yen while selling dollars, Treasury bond yields could rise further. Furthermore, on July 31, Treasury Secretary Scott Besant announced plans to expand the Foreign and International Monetary Authority (FIMA) Repurchase Agreement (Repo) facility, which allows the Federal Reserve to lend dollars using U.S. Treasury bonds as collateral. If Japan utilizes this facility, it can borrow dollars to prop up the yen without selling U.S. Treasury bonds. Moreover, pressure was exerted on Japan to raise its benchmark interest rate to prevent the yen from weakening.

Furthermore, according to a report by The New York Times , the U.S. government and other developed nations are seeking to counter rising long-term interest rates by issuing short-term bonds with maturities of less than one year, instead of long-term bonds. In fact, on August 19, the U.S. Treasury Department decided to more than double the limit on buybacks of long-term bonds from a maximum of $2 billion per transaction to a minimum of $4 billion. However, this approach links the burden of national debt directly to short-term interest rates controlled by the central bank. It carries the risk that raising the benchmark interest rate to curb inflation will also lead to a corresponding increase in the government's borrowing costs. Ultimately, there is a growing call for efforts to curb excessive government fiscal deficits and manage fiscal soundness to prevent the current rise in bond yields. Additionally, stabilizing oil prices through an early end to the war with Iran could play a significant role in lowering prices.

Looking back, about a decade ago, as long-term government bond yields continued to fall since the 1990s, there were growing concerns about secular stagnation of the economy. U.S. Treasury yields remained low until the late 2010s, which was regarded as a phenomenon of economic stagnation characterized by insufficient aggregate demand, such as a lack of investment demand and slowing consumption. However, the situation is now rapidly changing due to the rise in long-term interest rates since 2020. With inflation becoming the backdrop of the times, concerns about insufficient demand and economic recession seem to have become a thing of the past.

However, it must be noted that the growth outlook for developed nations, including the United States, remains far from bright. In this regard, the recent rise in government bond yields is raising further concerns. Of course, it is unlikely that the situation will escalate to extreme scenarios, such as the government debt crises in Europe or the UK, where investors dump safe-haven government bonds and financial markets descend into chaos. Nevertheless, the continued deterioration of government finances and the sustained rise in long-term interest rates will undoubtedly cast a dark cloud over the future of the global economy, so this situation must be closely monitored.

(This article was originally published as a column in Hankyoreh in Korean and translated into English with the help of Google Translate. The views expressed in this article are those of the author(s) and do not necessarily represent the official stance of the center.)