The 5% bond market means pain is heading everyone’s way

NEW YORK – Not so long ago, families, businesses and governments were effectively living in a world of free money.

The US Federal Reserve’s benchmark interest rate was zero, while central banks in Europe and Asia even ran negative rates to stimulate economic growth after the financial crisis and through the Covid-19 pandemic.

Those days now look to be over, and everything from housing to mergers and acquisitions are being upended, especially after 30-year US Treasury bond yields this week punched through 5 per cent for the first time since 2007.

“I struggle to see how the recent yield moves don’t increase the risk of an accident somewhere in the financial system given the relatively abrupt end over recent quarters of a near decade and a half where the authorities did everything they could to control yields,” said Deutsche Bank strategist Jim Reid. “So, risky times.”

The importance of Treasuries helps to explain why the bond market move matters to the real world. As the basic risk-free rate, all other investments are benchmarked against them, and as the Treasury yield rises, that ripples out to broader markets, affecting everything from car loans to overdrafts to public borrowing and company loans.

And there is a lot of debt out there: According to the Institute of International Finance, a record US$307 trillion (S$419.7 trillion) was outstanding in the first half of 2023.

There are lots of reasons for the dramatic bond market shift, but three stand out.

Economies, especially the United States, have proved more robust than anticipated.

That, along with the previous dollops of easy money, is keeping the fire lit under inflation, forcing central banks to jack up rates higher than once thought and, more recently, stress that they will leave them there for a while.

As recession fears have ebbed, the idea that policymakers will have to quickly reverse course – the so-called pivot – is fast losing traction.

Finally, governments issued a lot more debt – at low rates – during the pandemic to safeguard their economies.

Now they have to refinance that at a much costlier price, sowing concerns about unsustainable fiscal deficits.

Political dysfunction and credit rating downgrades have added to the headwinds.

Put all these together and the price of money has to go up.

Some money market funds and even bank deposits are now offering a 5 per cent handle.

The German 10-year yield is at the highest since 2011, while even Japan’s is at a level not seen in a decade.

Housing market pain

For many consumers, mortgages are the first place that dramatic moves in interest rates really make their presence felt. Britain has been a prime example in 2023.

Many who took advantage of pandemic-era stimulus to take out a cheap deal are now having to refinance, and are facing a shocking jump in their monthly payments.

As a result, transactions are falling and house prices are under pressure.

Lenders are also seeing a rise in defaults, with one measure in a Bank of England survey rising in the second quarter to the highest level since the global financial crisis.

The mortgage cost squeeze is a story playing out everywhere.

In the US, the 30-year fixed rate mortgage has surpassed 7.5 per cent, compared with about 3 per cent in 2021.

That more-than-doubling in rates means that, for a US$500,000 mortgage, monthly payments are roughly US$1,400 extra.

Government pressure

Higher rates mean countries have to shell out more to borrow. In some cases, a lot more.

In the 11 months through August, the interest bill on US government debt totalled US808 billion, up about US$130 billion from the previous year. That bill will keep going up the longer rates stay elevated.

In turn, the government may have to borrow even more, or choose to spend less money elsewhere.

Others are also trying to deal with bloated deficits, partly the result of pandemic stimulus.

Britain is looking to limit spending, and some German politicians want to reinstate a ceiling on borrowing known as the debt brake.

Ultimately, as governments try to be more fiscally responsible, or at least give that impression, the burden falls on households.

They are likely to face higher taxes than otherwise, along with suffering financially strained public services.

Stock market risk

US Treasuries are considered one of the safest investments on the planet, and in the last decade or so the rewards for holding them were modest given suppressed yields.

As they now approach the 5 per cent mark, these bonds are looking much more attractive than riskier assets, such as stocks.

BMO Capital Markets head of interest rate strategy Ian Lyngen cautioned on Bloomberg Television this week that if 10-year yields hit 5 per cent, that could prove an “inflection point” that triggers a broader sell-off in risk assets such as stocks.

“That’s the biggest wildcard,” he said.

Companies squeezed

Companies spent the last decade raising cash at really cheap rates.

That has all changed, but most firms raised so much when rates were near zero that they did not need to tap markets when the hiking cycle began. The problem now is “higher for longer”.

Weaker companies that had been relying on their cash cushions to make it through this period of higher funding costs may be forced to tap markets to deal with a wall of debt that is coming due.

And if they do, they will need to pay almost double their current debt costs for cash.

Such strains could mean firms have to scale back investment plans or even look for savings, which may translate to job losses.

Such actions, if widespread, would have implications for consumer spending, housing and economic growth.

The changed world will also be a test for some of the newer corners of funding, such as private credit, which has yet to show how it would handle corporate defaults.

Office debt timebomb

Commercial real estate is a sector heavily reliant on borrowing vast sums, so the jump in debt costs is poison for the sector.

Higher bond yields have slammed valuations on properties as buyers demand returns that offer a premium over the risk-free rate.

That has bumped up loan-to-value ratios and increased the risk of breaching debt terms.

Borrowers face the choice of injecting more equity, if they have it, or borrowing more at costlier rates.

The other option is to sell properties into a falling market, creating more downward pressure on prices.

Compounding all of this is the structural shift that is hitting offices, as changing work habits and rising environmental regulations combine to make swathes of real estate’s biggest sub-sector obsolete, echoing the downturn that has already pummelled malls.

While a broader turmoil could emerge from anywhere, it is worth noting that property crises have frequently been the germ for a wider banking crisis.

Central banks aren’t wavering

Amid the market ructions, central bankers are not showing signs that they are wavering and ready to rush in to save the day.

That is because Fed chair Jerome Powell and his counterparts around the world have been focused on trying to slow their economies to a sustainable speed in order to get sky-high inflation down.

There is a risk that the slowdown becomes too pronounced, but for now, central bankers seem set in their position. bloomberg