Rising oil prices and mountains of debt are putting bond markets under pressure

Rising oil prices and growing mountains of debt are putting bond markets under pressure. This makes financing more expensive for states - and the problems for Finance Minister Klingbeil could grow.

It is becoming increasingly expensive for countries around the world to take on new debt. Yields in major bond markets have risen to their highest levels in years or even decades. The background is concerns about inflation, the high debts of many countries and the growing need for financing for investments in artificial intelligence.

In the USA, the world's most important bond market, the yield on 30-year government bonds reached 5.321 percent, the highest level since 2007. In Germany, the yield on ten-year government bonds climbed to 3.248 percent, the highest level since 2011. In Japan, the yields on ten-year government bonds approached the three percent mark - they have not been this high in around three decades. Yields also rose significantly in France. The yield on 30-year French government bonds rose to 4.9 percent, its highest level since 2008.

Kjersti Haugland, chief economist at the investment bank DNB Carnegie, therefore sees the bond markets at the beginning of a new era. The long phase of low interest rates and comparatively low inflation after the global financial crisis of 2008 is coming to an end. This comes at a time when public debt in many countries is already very high - particularly in Japan, the USA, France and Great Britain.

The immediate trigger for the recent rise in yields is fear of a further escalation of the conflict in the Middle East. Investors fear that a prolonged war could keep energy prices high, increasing inflationary pressure. This, in turn, could prompt the European Central Bank and the US Federal Reserve to keep interest rates high for longer or raise them further.

"It's not just the oil"

This is of great importance for the bond market. With higher inflation, the fixed interest payments of bonds that have already been issued lose real value. At the same time, older securities become less attractive when newly issued bonds offer higher interest rates. As a result, the prices of existing bonds come under pressure - and their yields rise. States must offer higher interest rates on new bonds in order to attract investors.

Additional inflationary pressure could also come from extreme weather and resulting delivery problems. Benjamin Schroeder from the major bank ING, for example, referred to supply chain interruptions in Germany as a result of extremely low water levels on the Rhine. "It's not just oil that people are looking at, but there is a broader inflation picture that is keeping the ECB on a hawkish path," he said.

The rise in yields has an impact far beyond government finances. Government bonds serve as an important reference value for the financing costs of companies and real estate. If their returns increase, loans for companies and private households often become more expensive. This makes investments more difficult and can slow down economic growth.

Investors are therefore paying particular attention to ten-year US government bonds. Your return is currently 4.74 percent, approaching the five percent mark. "This will be very important not only for bond markets but also for other financial assets, as any breakout to the upside is likely to undermine confidence," said Guy Miller, chief market strategist at insurer Zurich.

In addition to inflation concerns, the rising mountain of government debt around the world is putting a strain on the bond markets. “This is more of a constant, simmering concern that can flare up again and again,” said analyst Elmar Völker from Landesbank Baden-Württemberg. Investors therefore demanded a higher risk premium for government bonds with long maturities. “The markets are clearly demanding higher compensation for tying up capital over very long periods of time,” explained DNB-Carnegie chief economist Haugland.

Bad news for Klingbeil

There is also another factor: large US technology companies are raising enormous amounts of money on the bond market to finance their investments in artificial intelligence. In this way, they compete with states for investors' capital. The additional supply of bonds is contributing to the rise in yields, especially in the USA. “However, the associated effect can also have an impact on Europe,” said Völker.

For Finance Minister Lars Klingbeil, rising yields are bad news. In the long term, they make it more expensive to take on new debt and can therefore limit the scope for other government spending such as investments or social benefits. In the short term, experts believe the additional costs will remain manageable because the entire debt portfolio does not have to be refinanced at once. However, the longer interest rates remain at a high level, the more impact they have on the budget.

The total debt of the federal, state and local governments in Germany is heading towards four trillion euros, warned Friedrich Heinemann from the Center for European Economic Research months ago. If interest rates remain permanently high, annual interest costs could rise to 120 to 150 billion euros. This threatens to create a problematic cycle: higher interest rates make financing debt more expensive. Rising interest expenses, in turn, exacerbate concerns about the sustainability of government finances - and may lead to investors demanding even higher returns.