A worldwide slump in government bonds has led to an increased cost of debt for several nations, reaching levels not seen in over a decade. This is bad news for governments in debt and also affects mortgage borrowers, stock investors, and businesses. The sell-off is driven by investor expectations that major central banks will keep interest rates higher for an extended period to combat inflation. Here’s how it works: Governments issue bonds to raise money for public services and investments. Bonds allow them to borrow money from investors for a specific period, with regular interest payments. When official interest rates rise, yields on bonds increase. This incentivizes investors to sell their current bonds and buy newly issued ones that offer higher interest payments. As a result, bond prices decrease when yields rise. And yields are definitely on the rise, with US and UK government bonds reaching their highest levels in over a decade, and German and Italian bonds seeing similar trends. So, why should you care? Well, rising yields on government bonds lead to higher mortgage rates. Banks often use local government bond yields to price mortgages. For example, the disastrous budget announced by former UK Prime Minister Liz Truss in September caused UK government bond yields to skyrocket, resulting in increased mortgage costs. In November 2022, the average interest rate on a two-year fixed-rate mortgage reached its highest level since the global financial crisis of 2008. In the US, mortgage rates correlate with the yield on 10-year Treasuries, which has also been rising. Furthermore, the surge in government bond yields affects stock portfolios. When yields on government debt rise, shares generally lose value as investors can obtain higher returns and a stable income from less risky assets. This has caused stock indexes to decline in recent weeks, including the S&P 500, the Nasdaq Composite, the STOXX Europe 600, and London’s FTSE 100. Rising oil prices, a struggling Chinese economy, and the possibility of another US government shutdown have added to the decline in stocks. Additionally, higher interest rates increase borrowing costs for businesses. The cost of borrowing has already slowed, indicating a cooling economy, which aligns with the Federal Reserve’s objective. The government also faces the challenge of paying more interest on its debt, leaving less money available for other expenditures. The US government’s debt stands at an enormous $33 trillion and is projected to incur over $1 trillion in average annual interest costs over the next ten years. Similarly, the UK is expected to pay a significant amount of annual interest on its government debt this year, greatly surpassing its planned expenditure on key benefits. Higher bond yields mean that more funds must be allocated to debt interest, limiting the ability of politicians to reduce the cost of living through tax cuts or public sector pay offers.
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