Governments face extra debt costs as stimulus dries up

PARIS (AFP) - Governments face a rise in their borrowing costs due to the winding down of monetary stimulus programmes and as investors bet on central banks hiking interest rates sooner than promised.

Moody's Analytics warned this week that "US rates could rise as the Fed moves to slow its purchases of long-term debt, which in turn could push up the yields on European government bonds".

That has already begun. The yield on the debt of the United States and top European countries, as well as emerging economies, has risen recently as investors bet that the US Federal Reserve could begin as soon as next month to lower the amount of monetary stimulus it injects into the economy.

The US$85 billion (S$108 billion) per month that the Fed has ploughed into the US economy led to lower bond yields in the US, as well in many other countries as easy money went abroad from the US in search of somewhat higher risk and yields elsewhere. Recently, however, investors have factored in the prospect of the easy money tap being slowly closed down. This has pushed up yields on US Treasury bonds, and has caused some of the money placed abroad to be withdrawn, pushing up sovereign bond yields elsewhere.

The rate of return for investors on 10-year US Treasuries rose to two-year highs this past week, implying a more than 50 per cent increase in US borrowing costs since the beginning of the year. On Friday, 10-year Treasuries were trading at 2.812 per cent, up from 2.689 per cent at the beginning of the month and 1.828 per cent at the beginning of the year. Ten-year British gilts were at 2.704 per cent on Friday, up from 2.401 per cent at the beginning of August and 1.990 per cent at the beginning of the year.

At the height of the euro zone debt crisis, some euro zone money flowed into less risky bonds, such as French debt. But as the debt crisis eases, bond yields for the countries in trouble have fallen, and there are signs that yields on the safe haven countries may rise, with French bonds being closely watched.

For Germany, the yield on 10-year Bunds was 1.881 per cent on Friday, up from 1.667 per cent at the beginning of the month and 1.442 per cent at the beginning of the year. France's 10-year bonds yielded 2.4 per cent on Friday, up from 2.223 per cent at the beginning of August and 2.077 per cent at the beginning of the year.

The drop in sovereign bond yields to exceptionally low levels, thanks to the ultra-low interest rates set by central banks and huge monetary stimulus programmes, have masked the debt problems the countries face. Now, their governments face having to pay more to finance new debt as their borrowing costs rise in line with the yields on the secondary market where debt issued previously is traded.

The rise in sovereign yields has come even though central banks have pledged to keep those near-zero rates for the foreseeable future.

Bond analyst Rene Defossez at French investment bank Natixis said investors are starting to bet that the signs of economic recovery which justify the winding down of stimulus may induce central banks to raise rates sooner than they suggest.

"The factors which are pushing yields higher are tending to prevail" over the interest rate guidance issued by central banks, he said.