UK (Parliament Politic Magazine) – While casual pub conversations may not revolve around this topic, within the financial world, there’s a growing apprehension that has captured the attention of fund managers and investors alike: the bond markets.
These markets have been on a steady decline for a significant period, serving as a conspicuous warning signal regarding the health of the UK and US economies. This decline could potentially impact the interest rates for our loans and mortgages.
So, the question arises: just how concerned should we be?
What is A Bond?
Bonds are financial instruments through which governments raise capital by borrowing money. A bond represents a commitment to repay the borrowed funds at a future date. Typically, bondholders receive periodic interest payments throughout the bond’s duration.
In the United Kingdom, government-issued bonds are referred to as gilts, and they are widely regarded as low-risk investments, with a minimal likelihood of non-repayment. Similarly, in the United States, government-issued bonds are known as Treasuries, and they also carry a reputation for being highly secure investments.
What’s Happening In the Bond Market?
In the past year, a significant global sell-off of government bonds has unfolded, causing ripple effects throughout the financial landscape.
This trend coincides with central banks issuing warnings that inflation, the pace at which prices increase, is expected to remain elevated for a more extended period than previously anticipated.
Since 2021, central banks have taken multiple steps to combat inflation, gradually raising interest rates from near-zero levels to their current rates of 5.25% in the UK and 5.25% to 5.50% in the US.
When official interest rates increase, it typically leads to higher yields on government bonds, aimed at attracting buyers. This, in turn, pushes up borrowing costs for both governments and consumers.
For instance, in October, yields on benchmark 10-year US Treasuries exceeded 5%, marking their highest levels since just before the 2007 financial crisis. Similarly, in the UK, 30-year gilt yields reached a 25-year peak at 5.115% earlier in the same month, mirroring similar developments in Europe.
As yields rise, investors often opt to divest themselves of their existing bonds in favor of newly issued ones that offer more attractive interest rates. Consequently, bond prices tend to decline, impacting anyone who holds these assets – hence the noteworthy market fluctuations.
How Might this Impact You?
Government bond yields serve as a reference point for determining the interest rates on common loans and mortgages, which have surged in recent years.
For example, average mortgage rates in the United States reached a 20-year peak of 8% last month, placing significant pressure on borrowers. In the United Kingdom, the rate for a typical five-year fixed-rate residential mortgage stood at 5.87% as of October 31st, slightly lower than earlier in the year but still considerably higher compared to rates observed in previous years.
Increasing bond yields are exerting additional financial strain on governments. This is due to the fact that as yields rise, governments are obligated to allocate more resources to service their debt, potentially leaving them with reduced funds for other essential expenditures.
This scenario is expected to have consequences for whichever political party emerges victorious in the upcoming UK general election, anticipated to take place next year.
According to Simon French, a managing director at the investment bank Panmure Gordon, “As bond rates climb higher, the mounting interest payments reduce the available budget for crucial public services like healthcare and education.”
Is it Possible for Increased Borrowing Costs To Push Nations to the Brink?
Russ Mould, the investment director at AJ Bell, deems this prospect highly improbable. He points out that the UK has not defaulted on its debts since 1672, and the United States has never defaulted.
Nevertheless, he notes that investors are growing somewhat uneasy about the “manageability” of these countries’ debt burdens. This apprehension arises from years of extensive government spending in response to significant events like the 2007-08 financial crisis, the COVID-19 pandemic, and the Ukraine conflict.
The United States’ cumulative debt has reached $33.6 trillion, a substantial increase from $9 trillion in 2007. Meanwhile, in the United Kingdom, the national debt has risen to £2.5 trillion from £700 billion during the same period.
In theory, the greater the amount of debt interest that countries must pay, the more challenging it becomes for them to fulfill their obligations to invest