Why a rout in government bonds is worrying

Why a rout in government bonds is worrying

The world’s biggest bond markets are experiencing a new era of higher interest rates, leading to a bond rout. In the U.S., 10-year bond yields have reached 16-year highs, while in Germany they are at their highest since the 2011 euro zone debt crisis. Even in Japan, where rates are still below 0%, bond yields have returned to levels seen in 2013. This increase in government borrowing costs has implications for mortgage rates, loan rates, and overall market sentiment.

The rise in global bond yields can be attributed to expectations of sustained high interest rates. With inflation excluding food and energy prices remaining elevated and the U.S. economy showing resilience, central banks are resisting calls for rate cuts. Traders now anticipate the Federal Reserve cutting rates to only 4.7%, up from the 4.3% predicted in late August. Concerns about the fiscal outlook, including the U.S. rating downgrade and Italy’s increased deficit target, further compound worries. Higher deficits lead to more bond sales, which, combined with central banks reducing their holdings, result in rising longer-dated yields.

Many investors had been betting on bond yields dropping, so they are particularly sensitive to the opposite movement. The selloff in bonds has been driven by positive U.S. data, such as the recent upbeat manufacturing survey, which has pushed Treasury yields higher. However, Europe’s weakening economy may limit the extent of the selloff in that region, as bonds tend to perform better during economic downturns. Germany’s 10-year yield, currently at 2.9%, could soon reach 3%, a significant milestone considering yields were below 0% earlier this year.

The rise in bond yields has significant implications. U.S. 10-year Treasury yields have reached their 230-year average for the first time since 2007, highlighting the challenge of adjusting to higher rates. Higher yields increase governments’ funding costs, which becomes a concern as government funding needs remain high. In Europe, slowing economies will restrict the ability of governments to unwind fiscal support. However, higher yields are beneficial for central bankers as they raise market borrowing costs. Financial conditions in the U.S. are already restrictive, according to a Goldman Sachs index.

The ripple effects of the bond rout are far-reaching. Rising yields are causing losses on global government bonds, impacting investors who had been betting on a turnaround. The surge in bond yields is also diverting money away from equities, with the S&P 500 down approximately 7.5% from its peak in July. Banks, which hold long-end Treasuries, are particularly vulnerable to the bond selloff. Additionally, higher U.S. yields lead to a stronger dollar, putting pressure on other currencies, especially the Japanese yen.

Emerging markets should be concerned about the rising global yields, particularly those with higher-yielding and riskier economies. The additional yield that junk-rated governments pay on their hard-currency debt compared to safe-haven U.S. Treasuries has increased significantly. The intensification of the higher-for-longer narrative, along with rising oil prices, has also contributed to broad U.S. dollar strength, leading to weaker currencies, sell-offs in local rates, and wider credit spreads in emerging markets.

In conclusion, the bond rout and the rise in global bond yields have significant implications for various aspects of the financial system, including borrowing costs, market sentiment, equities, and emerging markets. Adjusting to higher rates poses challenges for investors and governments alike.

About News Team

Hi, I'm Alex Perez, an experienced writer with a focus on lifestyle and culture news. From food and fashion to travel and entertainment, I love exploring the latest trends and sharing my insights with readers. I also have a strong interest in world news and business, and enjoy covering breaking stories and events.

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