Blain’s Morning Porridge May 22^nd 2026 – Just how bad could the bond market get?

“Ships make no money sitting in port, so build and sail them to ride the storms that will inevitably assail them.”

In Bonds there is truth. While government bond yields have risen some 40-50 basis points since the Iran War, and yield curves have steepened, we are not in crisis territory yet. However, the risks of “higher for longer” rates, and sustained inflation have risen. These will impact credit markets and potentially trigger a cascading corporate crisis – leading to all kinds of hell that governments and central banks are now ill-equipped to deal with.

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Time to talk about the bond market.

The Iran inflation threat has led to mounting concern about what rising yields in Treasuries, Gilts and JGBs might herald in terms of recession and a crisis across bonds and credit. (What? You thought they were the same thing? Wrong…) Sovereign bond markets have steepened on the expectation of higher for longer interest rates primarily due to rising inflation expectations, but also due to the perception of escalating political incompetency – and it’s the yield on Bonds that set the risk rate for the whole economy.

Never underestimate the probability events and bad politicians will be able to steer us into full blown stagflation!  There is no shortage of headlines about what rising debt costs mean for the sustainability of Governments – particularly here in the UK, where Sir Keir Starmer’s hapless government is scared of everything, but thinks about the bond market in abject screaming terror.

Relax. It’s not the end of the world as we know it… Yet! It might become so.

Earlier this week I was writing about defence, and how “generals plan to win the last war, not the next one.” That is equally true in markets – we tend to think of the risks in terms of being the same ones that triggered the last crisis. But we are in a very different global reality today – the spirit of resolve and cooperation across the Atlantic and Europe that stayed the 2008 crisis no longer exists, and the global economy is a very different, challenging and inflationary place.

Today Iran, China / USA relations, the Xi axis, global trade and stressed supply chains all suggest global instability and uncertainty will remain elevated – meaning markets should be acutely sensitive to the factors causing yields to rise or fall. Add in the energy shock and you have the ingredients for a crisis cake. Yet, around the globe markets are bored and complacent to the news and data flow – and that makes the world fundamentally more vulnerable to a shock, and particularly a no-see-um event. (Like a Chinese blockade of Taiwan, or Trump deciding he’s had enough of it all and simply arresting every Democrat as a traitor – why not?)

Although traders may have stopped listening – assuming a solution is inevitable, Hormuz is becoming a very real crisis in the Real World. The rising incidence of riots, violence and strikes in Africa stem from sudden shortages of food and petrol, and increasing rates are putting economies into decline. We know difficulties in Africa translate into higher immigration stresses and challenges for Western governments to respond to. A riot in Kenya, or a butterfly triggering protests in India over fuel, may not seem like the Bond Market’s problem – but they inevitable become so.

The first folk in the West will know about how much the world has changed is still to come – it will be when flights start being mass-cancelled during the summer holidays, and food prices go through the roof! (And to cap it all, it looks like a super El-Nino event could deepen agricultural crisis next year!)

Back in the world of markets…

Bond investors care about one thing only – that they will be repaid principal and interest in a timely manner. When inflation rears its head, they fear what they will be repaid in 5 years-time will be worth considerably less than what the same money could buy today. When inflation is a threat the bond markets buy fewer bonds – thus yields rise, and duration shortens (meaning a multiple of short-dated bonds have to be sold to roll over existing debt!)

Bond buyers buy sovereign bonds because they expect Governments and Central Banks to honour their side of the trade by maintaining the value and purchasing power of the currency – which they do by keeping inflation at bay. If Governments are unwilling to do that – then the handshake at the crux of the bond markets is effectively worthless.

And if governments decide a bit of managed inflation, or some money printing through the monetary fiction of QE is in order… then let’s see who was being paying attention and understands what’s really going on in terms of what that then does to global bond and stock markets.

Let’s dismiss the myth that QE (quantitative easing keeping rates ultra-low) is non-inflationary. From 2009-2022 there was very little inflationary impetus and thus no momentum. China was exporting deflation around the globe as the cheapest to deliver manufacturing economy. Westen economies may have had cheap money, but they remained fundamentally flat-line in terms of growth. What did happen was stock markets exploded as bond yields were eased downwards – leading to the rising inequality issues we face today. The liquidity from QE did not flow into the real economy – it was spent on financial assets and stock buybacks. (Hence my observation that over the life of QE, US GDP effectively doubled, but the stock market rose 500%!)

A new run of QE (central banks effectively funding sovereign borrowing) would likely prove inflationary on the back of the very different geopolitical tensions in place today, and the increased frictions in trade and energy. Modest (i.e. lots) of 5% inflation might suit governments – inflation eats away debt piles, but the risk is a dangerous economic crash if accompanied by recession and crisis.

I noted up above that government bonds and credit are different things. Government bonds – at least those of financially sovereign nations – don’t go bust. They print money to repay debt – which is inflationary and likely to trigger all kinds of monetary and currency effects. (Which is why governments play the fiction of balancing the books.)

Credit, on the other hand, is highly vulnerable to monetary effects. If rates rise, corporates change their investment plans, cut costs, and struggle to meet their repayment schedules. They don’t have the luxury of financing themselves via QE.

It’s become fashionable to opine the next crisis could start in the private capital markets. Some think there is a vast swathe of debt risk in private credit – and sure enough the collapse of a few dodgy names and the shuttering of private credit funds to investor redemptions means many of the funds I speak to have put private credit investments on hold. (There are a good number of smart debt fund who are stepping up to actively seek distressed positions.)

However, its debt that underpins a large part of the private equity game. PE investors take their money out in the form of dividends paid for by massive amounts of leverage funded through junk bonds. There is a genuine concern about whether PE investors actually care if their portfolio companies default – they’ve effectively transferred equity risk to debt holders. What they care about is not being taxed on their carried interest!

In a push comes to shove bond market wobble, where suddenly Government bond rates spike because inflation puts everyone off buying longer dated bonds, and there are fewer people buying US Treasuries (because they hate Trump), Gilts (because Starmer does not impress), and JGBs (because they wonder how Japan survives), and its politically astute of China and other nations whom Trump has insulted to invest elsewhere… then we have a problem.

The crisis will happen in credit markets – probably in Junk. Rates will rise to attract bond buyers – and no-one wants to buy falling markets, so we have another liquidity crisis. That will impact corporate borrowing and consumer confidence to consume… and suddenly its 1973 again. The private equity bubble could pop, a raft of junk defaults hitting markets while consumers (represented by the unions) demand higher wages, and higher welfare handouts in return for their votes. Oh, dear… you can see where this is going.

And if QE is the solution govts and central banks resort to – will it work and trigger growth? Course not. Will it trigger a stock market boom? Maybe. Or will it trigger deeper inflation?

And how is a credit/liquidity event going to effect the AI bubble driving the US stock markets and its ongoing unfillable appetite for credit? Oh dear.

I will simply remind readers to take a look at how much AI is spending on datacentres and chips and ask whether that makes sense when the US 10-year bond hits 6%? Or higher!) And then I would say amuse yourself reading the SpaceX prospectus at wondering how much money it lost last year. Ask yourself if it’s the clearest signal ever of a frothy market top?

I would direct you to the following gem of a comment from Breakingviews this morning:

• “Elon Musk’s dream machine is a world-leading rocket maker glued to a third-rate ​chatbot lab. Yet silicon smarts ​account for over 90% of its ⁠claimed potential and three-quarters of ​capital spending. The problem ahead of ​a $75 bln IPO: xAI’s paltry growth as rivals hit light-speed.”

And on that happy thought I think I shall go sailing this long weekend and try to forget about it all… The sun is shining, the wind is blowing… what’s not to like?

Out of time, and back to the day job…

Bill Blain

Author of the Morning Porridge
CEO Windshift Capital
Advisor – Spitfire Strategic Capital

Meanwhile, don’t forget about my new book:

The Battle For Hamble is a proper grown-up examination of how bureaucracy has failed: a tale of Greedy Corporates, Bad Planning and Economic Illiteracy. It explains how a wholly unnecessary Gravel Quarry will be dug in middle of a prosperous village – putting 6000 jobs at risk. The truth is no one wants gravel, and the quarry company understands it’s not what you dig out, but what you stuff back into a hole in the ground that matters. Gravel sells for £30 a tonne – Landfill earns £150 a tonne to bury. Go figure.