Bond Bubble, Interest Rate Reversal and Public Debt – Why “Safe” Bonds Suddenly Became Risky

A professional overview by Ullrich Angersbach. 2026/06/26

1. Introduction: The underestimated risk in the bond market

For decades, bonds were considered the safe part of a portfolio. High-quality government bonds, bond funds and conservative balanced funds were often recommended as stabilizing components. The promise was simple: regular interest income, lower volatility and protection in times of crisis.

That perception has changed. The long period of extremely low and, at times, negative interest rates created a historic distortion in the bond market. Many bonds offered almost no return, but carried significant price risk. When interest rates started to rise again, these risks became visible.

Ullrich Angersbach summarizes: The bond bubble did not explode – it deflated slowly, and many investors only noticed it when they looked at their portfolios.

The key question is therefore not only: Is there a bond bubble? The more important question is: What does it mean for investors, bond funds, ETFs, life insurers, banks, governments and long-term wealth building?

2. What is a bond bubble?

A bond bubble occurs when bond prices rise sharply over an extended period and yields fall to levels that no longer adequately reflect the underlying risks.

In equities, excesses are often visible through high price-earnings ratios. In real estate, bubbles often appear through sharply rising purchase prices and low rental yields. In bonds, a bubble is primarily reflected in extremely low or even negative yields.

This may sound abstract, but it is crucial. Anyone buying a bond with a very low yield is paying a high price for very little ongoing income. If market interest rates rise later, the price of that bond falls.

The longer the maturity of a bond and the lower its coupon, the more sensitive it is to rising interest rates. That was the central risk of the bond bubble.

3. Why bond prices and interest rates move in opposite directions

Bonds follow a simple but often underestimated mechanism: when market interest rates rise, the prices of existing bonds fall. When market interest rates fall, the prices of existing bonds rise.

The reason is the fixed coupon. If an old bond pays only one percent interest while new bonds offer four percent, the old bond becomes less attractive to buyers. Its price must fall until its yield matches the new market environment.

Example: A long-term government bond with a low coupon was purchased during the zero-interest-rate period. If market interest rates rise significantly, the price of this bond can fall sharply, even though the government remains solvent. The main risk is then not default risk, but interest rate risk.

Exactly this interest rate risk was underestimated for many years.

4. Duration: The key risk concept for bonds

Duration measures, in simplified terms, how sensitive a bond is to changes in interest rates. The higher the duration, the more strongly the bond price reacts to a change in market interest rates.

A bond with a duration of approximately eight years loses roughly eight percent in price if the interest rate level rises by one percentage point. If rates rise by two percentage points, the price loss can be correspondingly larger.

This rule of thumb is not exact, but it illustrates the principle. Long maturities and low coupons make bonds particularly vulnerable to rising interest rates.

Many investors considered bond funds defensive without looking at the average duration within the fund. During the interest rate reversal, this became a serious problem.

5. The low-interest-rate period as the cause of the bond bubble

The foundation of the bond bubble was laid after the financial crisis of 2008. Central banks around the world lowered key interest rates to stabilize banks, support credit creation and prevent a severe recession.

What started as a short-term crisis measure turned into a long-lasting exceptional monetary environment in many currency areas. The European Central Bank, the Federal Reserve, the Bank of Japan and other central banks kept interest rates extremely low for years and purchased large volumes of government and corporate bonds.

The result: bond prices rose, yields fell, and many investors were forced to take on higher risks just to generate any return at all. Insurance companies, pension funds, foundations, banks and private investors all faced the same problem: safe yield became scarce.

During this phase, valuations emerged that would have been difficult to explain without the massive influence of central banks.

6. The role of central banks

Central banks were among the most important drivers of the bond bubble. Through low policy rates and extensive bond purchase programs, they pushed down yields in the capital markets. Government bonds benefited particularly strongly from this demand.

As of 17 June 2026, the three key ECB interest rates are 2.25 percent for the deposit facility, 2.40 percent for main refinancing operations and 2.65 percent for the marginal lending facility.

These interest rates show that the zero-interest-rate world is over. For bond markets, this is decisive. A higher interest rate environment changes the valuation of existing bonds, the refinancing costs of governments and companies, and the attractiveness of alternative investments.

The development of bond markets cannot therefore be viewed separately from monetary policy. Anyone who wants to understand bonds must understand central banks.

Further background on monetary policy can be found here: Ullrich Angersbach on central banks, money creation and inflation.

7. Government bonds: Safe, but not risk-free

Government bonds issued by countries with high credit ratings are often considered safe. This is often true with regard to default risk, but not with regard to price risk.

A German federal bond is usually not comparable to a highly speculative corporate bond. Nevertheless, even a German government bond can suffer significant price losses if it has a long maturity and interest rates rise.

On 26 June 2026, the yield on ten-year German government bonds was around 2.84 percent. This level is significantly higher than the extremely low yields seen during the zero-interest-rate period and shows how much the bond environment has changed.

For investors, this means: the question is not only whether a government will service its debt. The question is also at what price a bond was bought, what maturity it has and how sensitive it is to changes in interest rates.

8. Corporate bonds: Yield versus credit risk

Corporate bonds often offer higher yields than government bonds. However, this additional yield is not a gift. It compensates investors for additional risks.

These risks include credit downgrades, defaults, liquidity problems and price losses when risk premiums rise. It becomes particularly critical when companies borrowed cheaply during the low-interest-rate phase and later have to refinance at significantly higher rates.

The weaker a company’s balance sheet, the more dangerous the interest rate reversal becomes. Companies with high debt and low free cash flow come under pressure more quickly.

For investors, it is therefore not only the yield that matters, but the quality of the borrower.

9. High-yield bonds and the illusion of high returns

High-yield bonds are often presented as attractive sources of income. In reality, they are bonds issued by companies with lower credit quality. The higher coupon is compensation for higher risk.

In favorable market phases, high-yield bonds often appear stable. In crises, however, they can behave much more like equities. Risk premiums rise, prices fall and default risks increase.

Especially in an environment of rising financing costs, caution is required. Companies that were only viable at low interest rates can run into difficulties when rates rise.

10. Inflation: The silent enemy of bonds

Inflation is particularly important for bond investors. A bond pays nominal interest and a nominal repayment amount at maturity. What matters, however, is what that money is still worth in real terms.

If a bond yields two percent while inflation is three percent, the investor loses purchasing power in real terms. Even without a price loss, the investment can be negative in real terms.

The low-interest-rate period was therefore doubly problematic for many investors. Current income was low, while later inflationary pressures additionally reduced real purchasing power.

Bonds can create a sense of safety. Whether they preserve wealth in real terms depends on the relationship between yield, inflation, taxes and costs.

11. Public debt and interest burden

Global debt remains a central risk for bond markets. According to the International Monetary Fund, total global debt recently stood at slightly above 235 percent of global gross domestic product.

High debt makes governments, companies and private households more sensitive to rising interest rates. The higher the interest burden, the less financial room remains for investment, consumption, social spending or future-oriented projects.

Governments face a particular conflict. On the one hand, they need to refinance themselves. On the other hand, investors demand higher yields when inflation or perceived risks rise. This can put public budgets under pressure.

The bond bubble was therefore not only a capital market issue. It was also an expression of a world that had become accustomed to cheap money.

12. Has the bond bubble burst?

The bond bubble did not burst in a single moment. It was gradually deflated by the interest rate reversal. When central banks raised interest rates, the prices of many existing bonds fell.

Long-term bonds with low coupons were particularly affected. Bond funds and bond ETFs with high duration also suffered significant losses.

This revealed what had previously been hidden: safety in bonds does not automatically mean price stability. A bond can pay interest on time and still show a substantial loss in a portfolio.

13. Consequences for bond funds

Bond funds combine many bonds. This reduces the default risk of individual issuers. However, interest rate risk does not disappear.

If a bond fund holds many long-term bonds, it can suffer significant price losses when interest rates rise. Investors then realize that even funds that appear conservative can fluctuate.

The key factors are average maturity, duration, credit quality of the bonds held, currency risks and fund costs.

14. Consequences for bond ETFs

Bond ETFs are considered transparent and cost-efficient. Nevertheless, they carry the same fundamental risks as the bonds they hold. An ETF invested in long-term government bonds can fall sharply when interest rates rise.

Many investors focus mainly on costs and index names when choosing ETFs. With bond ETFs, however, the decisive questions are which maturities, credit qualities, countries and currencies are included.

A short-term bond ETF has a different risk profile from an ETF invested in long-term government bonds or global corporate bonds.

15. Consequences for life insurers and pension funds

Life insurers and pension funds traditionally invest heavily in bonds. The low-interest-rate phase put their business models under pressure because safe new investments generated hardly any return.

Rising interest rates improve reinvestment opportunities over the long term. In the short term, however, they can lead to valuation losses on existing bond portfolios.

This reveals a structural problem: institutions built around long-term guarantees are highly sensitive to extreme interest rate environments.

16. Consequences for banks

Banks are also closely connected to bond markets. They hold government bonds as liquidity reserves, collateral and investment assets. Rising interest rates can reduce the market value of these holdings.

As long as bonds are held to maturity, price losses do not necessarily have to be realized. Problems arise, however, when liquidity is needed and bonds must be sold at a loss.

The interest rate reversal therefore showed that bond risks do not only affect private investors, but the financial system as a whole.

17. Connection with equity markets

Bonds and equities compete with each other. When safe bonds offer hardly any yield, equities become relatively more attractive. This was an important driver of equity markets during the low-interest-rate period.

When bond yields rise, this relationship changes. Investors can once again generate income from interest-bearing investments, while equity valuations are scrutinized more closely.

At the same time, rising interest rates can weigh on corporate profits because financing costs increase and investment becomes more expensive.

Further background can be found here: Ullrich Angersbach on equities.

18. Connection with gold

Gold has a special relationship with bonds. Gold does not pay interest. For this reason, it is often viewed critically when interest rates are high. However, what matters is not only nominal interest rates, but real interest rates – interest rates after inflation.

Gold is also not a debtor’s promise to pay. This fundamentally distinguishes it from bonds. A bond is always a claim against a government, company or other institution. Gold, by contrast, is a real asset without counterparty risk.

In phases of lost confidence, high inflation or doubts about debt sustainability, gold can therefore play a special role in a portfolio.

Further background can be found here: Ullrich Angersbach on the gold price and monetary value.

19. Connection with real estate

Real estate markets are also closely linked to bond markets. Bond yields influence mortgage rates, discount rates and the attractiveness of alternative investments.

Low interest rates made real estate financing cheap and increased the willingness of many buyers to pay higher prices. Rising interest rates, on the other hand, reduce affordability and can put purchase prices under pressure.

The bond bubble was therefore part of a broader distortion in asset prices. Not only bonds were influenced by low interest rates, but also equities, real estate and other real assets.

20. Which bonds are particularly risky?

Not every bond carries the same risk. Particularly vulnerable are bonds with long maturities, low coupons, weak credit quality, low liquidity or currency risks.

Long-term bonds react strongly to changes in interest rates.
Bonds with low coupons offer little ongoing income buffer.
High-yield bonds carry higher default risks.
Foreign-currency bonds can be affected by exchange rate movements.
Subordinated bonds can fall particularly sharply in crises.
Illiquid bonds can be difficult to sell in market stress.

For investors, the exact structure is decisive. The word “bond” alone says little about the actual risk.

21. Which bonds can make sense?

Despite all risks, bonds are not unsuitable in principle. After the interest rate reversal, many bonds again offer yields above the levels seen during the zero-interest-rate period.

Short- to medium-term bonds with high credit quality can be useful if they are bought at a reasonable price and match the investor’s risk profile.

A maturity ladder can also help. This means combining bonds with different maturities in order to spread reinvestment risk and interest rate risk.

The key point remains: bonds are not a risk-free parking space for capital. They are a tool that must be understood and used correctly.

22. What investors should learn from the bond bubble

The most important lesson from the bond bubble is this: safety must not be confused with the absence of volatility. Even high-quality investments can suffer significant price losses.

Investors should pay particular attention to the following factors when evaluating bonds:

Yield to maturity
Remaining maturity
Duration
Credit quality of the issuer
Currency
Liquidity
Costs of funds and ETFs
Inflation after taxes and costs

Anyone who ignores these factors is assessing bonds only superficially.

23. Bonds in a portfolio

Bonds can still play a useful role in a portfolio. They can provide current income, reduce fluctuations and make liquidity more predictable. The right selection, however, is crucial.

A robust wealth structure should not rely solely on bonds. Broad diversification across asset classes, regions, maturities and currencies is essential.

Equities can represent long-term productive capital.
Bonds can provide income and predictability, but carry interest rate and credit risks.
Liquidity creates flexibility.
Gold can serve as a confidence and crisis component.
Real estate can have real asset characteristics, but remains strongly dependent on interest rates.

Further background on wealth structuring can be found here: Ullrich Angersbach on portfolio construction.

24. Bond bubble and stock market crash

A bond bubble can also affect equity markets. When bond yields rise sharply, equity valuations come under greater pressure. At the same time, financing costs for companies increase.

In extreme cases, rising interest rates, falling bond prices and falling equity markets can occur simultaneously. In such phases, the traditional assumption that bonds automatically stabilize a portfolio no longer works.

Especially balanced funds and traditional 60/40 portfolios can come under pressure when equities and bonds fall at the same time.

Further background can be found here: Ullrich Angersbach on stock market crashes.

25. Conclusion: The bond bubble as a warning signal

The bond bubble was the result of a long phase of extremely low interest rates, expansionary central bank policy and strong demand for supposedly safe investments. It showed that even conservative asset classes can carry substantial risks.

With the interest rate reversal, it became clear that many bonds were not risk-free, but had only appeared risk-free for years. Long-term bonds with low coupons in particular lost significant value.

For investors, this means: bonds remain important, but they must be understood correctly. Yield, maturity, duration, credit quality, inflation and the role of the bond within the overall portfolio are decisive.

Ullrich Angersbach summarizes: The bond bubble did not explode – it deflated slowly, and many investors only noticed it when they looked at their portfolios.

Frequently asked questions about the bond bubble

What is a bond bubble?

A bond bubble occurs when bond prices rise sharply over a long period and yields fall so low that the actual risks are no longer adequately compensated.

Why do bonds fall when interest rates rise?

Existing bonds have fixed coupons. When new bonds offer higher interest rates, older bonds must fall in price so that their yield matches the current market level.

What does duration mean?

Duration describes the interest rate sensitivity of a bond. The higher the duration, the more strongly the price of a bond reacts to changes in interest rates.

Are government bonds safe?

Government bonds issued by high-quality borrowers often have low default risk. However, they can still suffer significant price losses when interest rates rise or when long maturities are held.

Are German government bonds risk-free?

German government bonds are considered very strong in terms of credit quality, but they are not risk-free. Long-term German government bonds in particular can fall significantly in price when interest rates rise.

What is the difference between coupon and yield?

The coupon is the fixed interest rate paid by a bond. The yield also depends on the purchase price, remaining maturity and repayment value.

Why were negative yields problematic?

Negative yields meant that investors accepted a nominal loss if they held the bond to maturity. At the same time, price risk in the event of rising interest rates remained.

Can bonds become worthless?

Yes. If an issuer defaults, bonds can lose substantial value or become almost worthless. With high-quality government bonds, this risk is lower, but it should not be confused with price risk.

Are bond funds safe?

Bond funds diversify across many bonds, but they still carry interest rate risk, credit risk, currency risk and liquidity risk.

Are bond ETFs safe?

Bond ETFs are transparent and cost-efficient, but they are not risk-free. Their risk depends on the maturities, credit ratings, countries, currencies and duration of the index.

Which bonds are particularly risky?

Particularly risky are long-term bonds with low coupons, high-yield bonds, subordinated bonds, foreign-currency bonds and bonds issued by weak borrowers.

Which bonds are less sensitive to interest rates?

Short-term bonds generally react less strongly to interest rate changes than long-term bonds.

Do bonds benefit from falling interest rates?

Yes. When interest rates fall, the prices of existing bonds generally rise. Long-term bonds benefit particularly strongly in such an environment.

Why does the bond bubble also affect equities?

Rising bond yields make safe interest-bearing investments more attractive and increase financing costs for companies. This can put pressure on equity valuations.

What does the bond bubble mean for investors?

Investors should not view bonds as automatically safe. Maturity, duration, yield, credit quality, inflation, costs and the role within the overall portfolio are decisive.

Internal further reading

Sources and further information

About the author

Ullrich Angersbach holds a degree in business administration and is a wealth manager and marketing coach for fund management companies. He completed his studies in business administration at Ludwig Maximilian University of Munich in 1979. His thesis, “The Builder Model – Information for Capital Investors and Investment Advisors,” was published in the same year and dealt with tax aspects of real estate investments.

After completing his studies, Ullrich Angersbach worked for many years in an independent wealth management company, including two years in the United States. He later managed a family office in Switzerland and subsequently helped build an international sales organization for fund investments offered to qualified institutional investors.

Since 2008, Ullrich Angersbach has worked independently as a marketing coach. He supports fund management companies with his many years of professional experience and publishes specialist articles on monetary policy, capital markets, wealth building, financial products and investment strategies.

Disclaimer

The information provided by Ullrich Angersbach in this document is for informational purposes only and does not constitute financial, investment or legal advice. The examples and strategies presented are hypothetical and should not be used as the basis for actual investment decisions. Every investment involves risks, and past performance does not guarantee future results.

Please consult a qualified professional adviser before making financial decisions. Neither the author nor the company accepts responsibility for any losses or damages that may arise from the use of the information contained in this document.