Something BIG just broke in the bond market
Take a look at this chart. It tracks something called the global bond liquidity, which is a measure of how easily government bonds can be bought or sold without triggering a big price movement.Past performance isn’t a reliable indicator of future results.
When this line falls, it means liquidity is strong, and when it rises, it points to a shortage in liquidity.
Recently, this index has spiked to its highest level on record since 2007, telling us that global bond market liquidity just got exceptionally tight. The last two times it reached similar levels were back in 2022 and 2008. Both of these instances coincided with sharp stock market drawdowns as an economic downturn unfolded. Yet today, stocks remain at record highs and US GDP is still expanding at 3.8%—not the type of backdrop typically seen during such severe bond market liquidity stress.
This big disconnect could have major implications for the US economy
To understand what's really happening today, we must first go back to 2022.
Back then, the Fed raised rates at one of the fastest paces in decades, even to the point where it's actually higher than the 30-year government bond yields. That meant investors could earn better returns just by holding cash or money market funds, making older bonds with lower yields far less attractive. As a result, money started shifting out of long-term bonds and into cash-like assets, draining demand from the bond market.
At the same time, governments were issuing a record amount of new debt, flooding the market with supply just as buyers were stepping back. This is a classic case of bond liquidity problems—a supply and demand imbalance. And along with inflation, that tightening in bond markets played a major role in triggering the market downturn.
In 2008, the story was a little different
The housing bubble burst, major banks collapsed, and funding markets froze, making it difficult to trade bonds—hence the liquidity drops. But once again, liquidity stress and market downturns come hand-in-hand.
In both of those cases, the stress was centered in the United States, home to the world's largest government bond market. But the liquidity index isn't just about the US. It reflects conditions across all major bond markets globally—from the US to Europe, China, and Japan. Whether today's liquidity problem spills over into the economy depends on where that stress is actually coming from.
One way to see that is through government bond yields
When liquidity dries up, bonds become harder to trade, causing prices and yields to swing more sharply.
If we look at the data, 30-year bond yields in the US have actually stabilized around 4.5% in recent months. In Europe and China, 30-year yields have also remained relatively steady. That suggests the liquidity stress isn't coming from these markets.
Which leaves us with Japan.
Japan's 30-year bond yields have jumped from 2.2% at the start of the year to around 3.1% now. That shift signals that the current liquidity strain may be starting from Japan, and that brings new risks for Japan's economy.
Higher yields translate into more expensive borrowing for the government, higher mortgage rates for households, and rising financing costs for businesses. In other words, tighter financial conditions that could weigh on growth.
But the impact doesn't end there. Many analysts warned that stress in Japan's bond market has the potential to ripple across the global bond market—including the US. That's because Japanese investors are the biggest foreign holders of US treasuries, with more than $1.1 trillion in holdings, and have long been major buyers of US debt.
But with yields at home now rising, those same investors have more incentive to bring capital back to Japan. That could mean scaling back on foreign bonds. If this trend continues, it could reduce demand for US debt.
This comes at a particularly challenging time for the US. This chart shows Treasury auctions—or in other words, the supply of new government bonds hitting the market. In 2025, issuance is set to exceed $31 trillion, the highest on record.
The US relies on both domestic and foreign investors to absorb this massive supply. If issuance keeps climbing while demand weakens, liquidity could suffer, making it harder for the bond market to function smoothly.
So, should investors brace for another major economic downturn triggered by a debt crisis that starts in Japan?
Well, what happens next will largely depend on how the Fed and governments respond.
If central banks sit back, yields could keep climbing—not because of strong growth, but because liquidity is drying up, just as we've already seen happen in Japan. That would mean higher borrowing costs for governments, worsening deficits, and tighter financial conditions. We might just see a lag, and the shock we're seeing in Japan could actually ripple to the US, raising the risk of recession.
But right now, we're beginning to see a sign of intervention. The Fed has already started cutting rates again in September after keeping them steady for 8 months and has signaled it's open to further reductions.
If we overlay 30-year yield on top, we can see that long-term yields often follow once policy rates begin to drop. By lowering short-term interest rates, the Fed makes cash and money market instruments less attractive. That can encourage investors to shift back into treasuries, helping to improve demand and ease some of the strain in the bond market.
Ultimately, whether this develops into broader stress depends on whether the intervention is enough to improve this liquidity problem.
If this support is enough, liquidity should gradually improve. Yields could stay contained and the economy might avoid a downturn. But if yields keep climbing despite these efforts, it could be a warning sign that risks are building beneath the surface.
At Capital.com, we'll continue to track the government bond liquidity, yields, and the other key indicators shaping the economy and markets and keep you posted. Explore more insights in our Educational Hub.