Bond yields surge amid global inflation, debt concerns, and capital competition

What are bonds, anyway?

Bonds are essentially an IOU from a government to pay you back in a set number of years’ time, alongside a regular interest payment along the way.

These assets are bought and sold on the biggest market in the world – the bond market.

That means the price of the bond can fluctuate as it changes hands, before it’s ultimately repaid.

The key thing to know is that when the bond price goes down, the yield on that bond goes up (and vice versa).

So surging yields over recent weeks means we are experiencing a major bond sell-off.

Why are bond yields climbing so much?

Experts say many forces are coming together to drive yields higher, and not just in recent weeks.

As Adam Donaldson, CBA’s head of rates research, explains: “Bonds are the benchmark against which other assets are measured and a barometer of the future outlook for growth, inflation, debt sustainability and the cash rate.”

With the conflict in the Middle East showing no signs of ending, investors are factoring in more persistent inflationary pressures around the world.

That means central banks are more likely to either be delivering more rate hikes to keep price pressures under control, or are less likely to be cutting.

Either way, bond yields need to be higher to reflect higher inflation and higher rates.

Experts also say the recent spike in bond yields reflects rising concerns about the immense levels of debt across the developed world and, especially, in the United States.

The American government is spending more money on servicing its US$40tn debt pile than it is on defence. In fact, net interest payments of US$1.2tn a year make it the second biggest spending item in the US budget.

Nobody thinks the Americans are about to default on their debt, but the developed world’s borrowing burden is chipping away at trust in governments’ capacity to manage their budgets, and bond investors are demanding a higher interest rate to account for that.

But for Donaldson, the change is more fundamental and long lasting.

“We think that in the background it is the competition for capital that is the driving force here,” he says.

The balance between investment and savings has “shifted decisively over the past 10 years”, and not just because of countries’ ever expanding appetite for debt and spending.

The massive tech companies are borrowing vast amounts to invest as they race for a top spot in the artificial intelligence industries of the future, whether in datacentres or semiconductors.

“And now because there is a shortage of savings to fund all this spending globally it is putting pressure on interest rates,” Donaldson says.

“That means the average cash rate is going to have to be quite a bit higher than what they anticipated it would be before Covid and in the years since.”

Wait, does that mean more expensive mortgages?

Analysts say that the lift in bond yields is signalling that money will be more expensive in the future than it has been – and, yes, that does include your home loan.

(It’s also worth noting that almost everyone who has super will have some money in bonds. So if nothing else, the paper value of those bonds will have taken a bit of a hit.)

To be clear, a rise in bond yields doesn’t directly flow through to a higher mortgage rate. But it does tell you something about where your borrowing rates will be in the future: again, higher than they have been in the past.

Chris Richardson, the independent economist, says “in effect the price of the future, everything that requires us to borrow money to do it, will be higher”.

“That’s true for every government, for every wannabe homeowner, for every major tech company, and for a whole bunch of other businesses as well.”

Or to put it another way: “The world’s largest market, the market where people have the most money at stake, is saying to everybody else, ‘Are you sure?’”

This holds true for governments in Australia.

The 15-year high in 10-year bond rates comes days after the federal debt passed $1tn for the first time. The cost of servicing that debt was already one of the fastest growing items in the budget.

This climbing public debt burden will become more pressing as the decade progresses and debt that was taken out at extraordinarily low levels during the pandemic needs to be rolled over, Richardson says.

“Our government debts aren’t bad by world standards, but it’s still a lot of debt, and every time governments are making decisions that cost money right now, the bond market is tapping the sign and saying, ‘Are you sure?’”