Why you should care about the global rout in government bonds
Story by By Anna Cooban, CNN, 10/5/23
A slump in government bonds around the world has pushed up the cost of some nations’ debt to levels not seen in more than a decade. That’s bad news for governments in the red but also for the wallets of millions of mortgage borrowers, stock investors and businesses.
The sell-off has been fueled by expectations among investors that the world’s major central banks will keep interest rates “higher for longer” to bring inflation down to their targets.
It works like this: Governments looking to raise cash for public services and investments issue bonds. A bond provides a way to borrow money from investors for a set length of time, with the obligation to make regular interest payments.
When official interest rates rise, so do investors’ expectations for returns on bonds, known as yields. This creates an incentive for investors to sell the bonds they currently hold and buy newly issued ones that offer higher interest payments. Selling bonds reduces prices. So, in short, when yields rise, bond prices fall.
It works like this: Governments looking to raise cash for public services and investments issue bonds. A bond provides a way to borrow money from investors for a set length of time, with the obligation to make regular interest payments.
When official interest rates rise, so do investors’ expectations for returns on bonds, known as yields. This creates an incentive for investors to sell the bonds they currently hold and buy newly issued ones that offer higher interest payments. Selling bonds reduces prices. So, in short, when yields rise, bond prices fall.
Yields on German long-dated bonds are back to levels last seen on the eve of the eurozone debt crisis in 2011. Yields on Italy’s 10-year bonds hit 5% on Wednesday, the highest level since 2012, when that crisis was in full swing.
Here’s why you should care.
Mortgage rates rise
The yields on local government bonds are usually used by banks to price mortgages.
The disastrous “mini” budget unveiled by former UK Prime Minister Liz Truss in September last year provided a stark illustration of that relationship. Her plan to borrow tens of billions of pounds to fund tax cuts spooked bond investors who feared that the country’s finances were on an unsustainable path.
The resulting sell-off in UK government bonds — called “gilts” — caused yields to shoot up, taking mortgage costs higher with them.
The average interest on a two-year fixed-rate mortgage soared to 6.47% at the start of November 2022, according to data from product comparison website Moneyfacts, the highest level since the depths of the global financial crisis in August 2008.
That meant hundreds of pounds more a month in mortgage payments. Before higher mortgage rates kicked in, some panicked homeowners rushed to refinance their fixed-rate loans earlier than planned, accepting a financial penalty for doing so.
Mortgage rates had been falling back since the drama last fall but are now back to 6.47%, this month’s data from Moneyfacts shows.
In the United States, mortgage rates tend to track the yield on 10-year Treasuries, and that yield has risen 0.27 percentage points since late September.
On Thursday, government-backed mortgage provider Freddie Mac announced that the average interest on a 30-year fixed-rate mortgage had hit 7.31% in the week ending September 28 — its highest level since 2000.
“Higher mortgage rates create a standoff between potential buyers, who face some of the highest borrowing rates since 2000, and sellers, who may already enjoy a low fixed-rate mortgage and thus are less incentivized to sell,” Andrew Sheets, global head of corporate credit research at Morgan Stanley, told CNN.
Stocks take a hit
Surging government bond yields are probably coming for your stock portfolios too.
Shares typically lose value when the yields on government debt rise, as investors can now get high returns — and a steady income — from less risky assets.
Take the yield on 10-year Treasuries: at 4.78%, it is more than twice as high as the average yearly dividend paid out by the companies making up the S&P 500 index (SPX).
“The higher the gilt yield goes, the less inclined, or obliged, investors will feel to take risk and pay up for other asset classes, such as shares,” Russ Mould, investment director at AJ Bell, told CNN.
Stock indexes have tumbled on both sides of the Atlantic in recent weeks. The S&P 500 and the tech-heavy Nasdaq Composite (NDX) have shed 4% and 2.3% respectively since the Federal Reserve said late last month that it could hike rates once more this year and expected to make fewer rate cuts in 2024.
The STOXX Europe 600 has sunk 4.5% and London’s FTSE 100 4.3% in that time.
“Income is back,” analysts at BlackRock, the world’s biggest asset manager, wrote in a note Monday, recommending investments in short-dates US Treasuries.
Stocks have also taken a hit in recent weeks as rising oil prices, an ailing Chinese economy and the prospect of another government shutdown in the United Stated have unnerved investors.
High official interest rates in America and Europe have also raised the cost of borrowing for businesses.
“Higher interest rates make borrowing less attractive, and we’ve already seen a sharp slowing of bank lending that we think is consistent with this idea,” said Sheets at Morgan Stanley.
“It’s important to note that slower credit growth, which generally means a cooler economy, is precisely what the Federal Reserve is trying to achieve through its large recent rate hikes,” he added.
Squeeze on public services
Higher yields also mean that the government must pay more to service its debt — with less money available to spend elsewhere.
The US government is currently sitting on a $33 trillion debt pile and is expected to incur more than $1 trillion in average annual interest costs over the next decade.
In March, when gilt yields were much lower than now, the UK’s public spending watchdog said it expected the annual interest paid on the government’s pile of debt to peak at £115 billion ($140 billion) this year. That’s almost three times as much as the UK government plans to spend in 2023 on a key benefit for children and people with disabilities.
Rising bond yields mean that “for any given level of borrowing, more must be spent on debt interest, leaving less scope to finance other priorities,” the Office for Budget Responsibility said in its March forecast.
Higher gilt yields give politicians “less wiggle room to ease [the] cost-of-living pain through tax cuts or public sector pay offers,” Susannah Streeter, head of money and markets at Hargreaves Lansdown, wrote in a note Wednesday.