Except on rare occasions – last year’s post-Liz Truss mini-budget episode being one of them – the bond market rarely garners as much attention as other financial sectors.
Yet these markets, where companies and governments come to borrow, are the foundations for the global economy.
In particular, the value of government bonds – and hence their imputed interest rates – have an enormous bearing on all of our lives. Higher bond yields, as these interest rates are called, imply that we will all be paying more interest on that debt for years to come.
So the fact that these interest rates are shooting up rapidly around the world in recent weeks is no trivial matter. On Monday morning, the yield on US 10-year debt (typically seen as a benchmark for this market) broke through the 5% mark.
The UK’s own 10-year government debt is, at 4.7%, now above the highs it hit following last autumn’s mini-budget.
The 30-year UK government bond yield just hit the highest level since 1998. This is big stuff – and indeed the degree of yo-yoing in recent weeks has been unprecedented.
Something is clearly going on in these markets, but what?
This is where things get a little murkier, because it turns out there is no single, definitive explanation for these fluctuations. That comes back to a broader point, which is that the price of a given country’s debt is telling you lots of things at the same time.
It could be telling you about future expectations for where central bank interest rates are heading in future. At one and the same time, it could be signalling how much demand there is in capital markets for a given country’s debt. It could equally be caused by supply: if a government is issuing lots of debt, you might reasonably expect people to ask for higher interest rates to lend them that money.
And the explanation for the recent rise in bond yields could well be all of the above.
A lot of debt
It’s worth saying, before we go into it, that most of this shift seems to be centred on the US economy – but any rise in Treasury yields (those US government bonds are typically referred to as “Treasuries”) has a direct impact on the rest of the world. So it matters for everyone.
Anyway, let’s take the central bank thesis first. Up until quite recently, most economists and investors had been assuming that having risen sharply in recent years, official central bank interest rates would be cut quite rapidly next year – that the shape of the future interest rate curve might resemble the Matterhorn, that Swiss mountain which used to be on the side of Toblerone packages until they stopped making the chocolate in Switzerland.
But central banks, including the US Federal Reserve and Bank of England, have been at pains recently to signal that those rates might not be coming down quite so quickly.
In fact, says Bank of England chief economist Huw Pill, the future path for interest rates might look a bit more like Table Mountain – a long, flat plateau of higher rates.
So that’s one part of the explanation. Another is that right now the US government is borrowing enormous amounts of money, partly to finance its Inflation Reduction Act and CHIPS Act, as well as new Biden administration welfare policies.
The combined effect is, according to the Congressional Budget Office, to lift the US national debt up to the highest levels since the aftermath of WWII.
That’s a lot of debt – and while everyone’s known about these plans for some time, it’s possible investors are only now beginning to baulk at the prospect of absorbing all that debt.
The final explanation, which is considerably more speculative but also more unsettling, comes back to something else.
You may recall that after Russia invaded UkraineWestern nations talked about doing what they could to ensure Russia would pay for reconstruction in Ukraine, including potentially seizing Russian assets held in Western nations.
No one is entirely sure how this would work, but at the recent IMF annual meetings in Marrakech, the group of seven leading economies (the US, Japan, Germany, the UK, France, Canada and Italy) agreed to begin working on it.
As I say, no-one is entirely sure how this should be done. It might be possible to confiscate some of the interest payments which might otherwise have been due to Russia, earnt by Russian assets held in Europe.
But the G7 is also aware that this is dangerous territory, begging questions about the function of international law and the international monetary system.
It also sends a pretty clear message to other countries. If the G7 is content to start seizing Russian assets in their countries then what is to stop them doing likewise with, say, Chinese assets?
Perhaps you see where this is going. At the moment, China is one of the biggest buyers of US government debt, and there is evidence that it is slowing its purchases of US government debt.
Might that be because it’s somewhat spooked by the ongoing efforts to recoup money from Russia? Might Chinese authorities worry that something similar could or would happen to its holdings of US Treasuries if it invaded Taiwan? No one knows for sure, but this is another not altogether implausible explanation for those higher bond yields.
All of which is to say: it’s complicated. But it’s also quite scary. And higher interest rates mean higher debt repayment costs for this country in the coming years.
The ability of this government (or a possible future Labour government) to borrow to finance big projects in future depends on being able to borrow at a reasonable interest rate. And those interest rates are getting considerably higher.