This week, U.S. borrowing costs reached a level not seen since before the Global Financial Crisis.
Around the world, in countries like Australia and the UK, borrowing costs have seen a similar surge in the past year.
Investors are worried about inflation and rising interest rates, and the bond market has taken a beating.
What exactly is happening, and how might it impact you?
Bonds
Bonds are tools used by governments and companies to borrow money.
Let’s say a government wants to borrow $1,000 from you and will pay you back in 10 years.
They’ll give you $30 every year as payment, meaning the return (or “yield”) of this 10-year bond is 3%.
Now, let’s say you want to sell this bond to another investor, but you’re having trouble finding a buyer.
When you do manage to find a buyer, they only pay $750 for the bond.
The bond still pays $30 a year (and gives back the $1,000) after 10 years, but under the new price, the yield is now 4%.
In this example, the bond yield rose (or “spiked”) from 3% to 4%.
When bond yields spike, it generally means there aren’t enough investors willing to buy the bonds at their old prices.
What would cause investors to stop buying?
Before we answer that, let’s see what happened in the real world.
The bond market
Yields of 10-year bonds are used as the benchmark for the borrowing costs of an economy.
Over the past year, bond yields in most developed countries have been rising, and the past week saw a sharp acceleration.
On Tuesday, U.S. bond yields reached 5.04%.
This was the highest yield since before the Global Financial Crisis.
The last time yields crossed 5% at all was in October 2023.
The drivers
Remember, bond yields spike because there aren’t enough investors willing to buy them at their old prices.
Generally, the reasons are because: investors want more compensation to buy them, or there are more bonds on offer than there is money to buy them.
Market analysts point to several factors that have caused the spikes seen in recent months.
Rising oil prices
Oil prices skyrocketed after the U.S. and Israel attacked Iran in February.
High oil prices will likely contribute to higher inflation in the near future.
This means the $30 a year you will earn from the bond will quickly lose its value over time.
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High inflation
Speaking of high inflation, oil is only one factor contributing to rising prices.
Persistent high inflation continues to be an issue across many developed countries.
Again, your $30 a year will lose value over time.
Rising interest rates
Central banks have been increasing their cash rates in response to high inflation, with more hikes likely to come.
When cash rates increase, newer bonds will pay a higher return (say $50) compared to the current $30 payments.
This makes the current bonds less attractive.
High government debt
A month ago, U.S. and Australian debt passed $US40 trillion ($AU56.1 trillion) and $AU1 trillion respectively.
Too much government debt means there is more supply of bonds than demand, causing bond prices to fall.
AI borrowing
AI companies have been borrowing billions of dollars recently in order to fund their expansions.
Money that is used to fund AI companies (and companies in general) is money that is not used to fund government borrowing.
Thus, to attract investors, government bond prices have fallen.
In other words, bond yields have risen.
According to The Economist, corporate bonds have increased bond yields by 0.2 percentage points.
How this affects you
Rising bond yields affect many areas of the economy by increasing borrowing costs.
If bonds are giving investors higher returns, banks need to increase their own rates to be able to compete with them.
These increased rates are passed onto you.
If you’re looking to borrow, such as for a car or a house, this means that rising yields will decrease your borrowing capacity.
If you currently have a loan on a variable interest rate, the increased rates will increase your monthly repayments.
Similarly, if you have a savings account, your monthly interest will also increase.
If you invest in the stock market, rising yields generally lower stock market returns.
This is because higher yields could draw investors away from stocks, decreasing their prices.
Higher yields don’t just affect you.
Governments and companies looking to borrow also face higher costs, which means economies won’t be able to grow as fast.
