Bonds

What are bond yields and why are they at a 25-year high in UK?


Borrowing costs for governments around the world have risen to the highest level in decades as investors bet that stubbornly high inflation will force global central banks to leave interest rates higher for longer.

UK 30-year bond yields – which dictate the country’s long-term cost of borrowing – rose to the highest level since 1998 on Wednesday, surpassing the levels seen a year ago in the panic after Liz Truss’s mini-budget. US Treasury yields have climbed to a 16-year high, while EU nations and Japanese government borrowing costs have also risen sharply.

What are bond yields?

A bond is a form of loan that investors make to a borrower, or bond issuer. Governments, companies and other organisations issue them to raise money. The bond market is the biggest securities market in the world, worth almost $130tn (£107tn). The US bond market is the largest, accounting for about 40% of debt worldwide. UK government bonds are also commonly referred to as gilts, while US ones are known as Treasuries, and German ones as bunds.

Bond yields represent the amount of money an investor receives for owning the debt as a percentage of its current price. When the price of a bond falls, yields rise. The yield is also commonly referred to as an interest rate, or the “cost of borrowing” to an issuer.

Rising bond yields suggest dwindling appetite to own the debt among investors, which can be influenced by a range of factors – including an issuer’s ability to repay. For governments, this centres on the prospects for the economy and national finances.

Inflation expectations also have a significant impact. This is because inflation undercuts the future value of money received for owning the debt. This means investors could demand a higher yield to compensate for the risk.

Why are yields rising now?

Investors are betting that the world’s most influential central banks will keep their official interest rates set at high levels for longer than previously anticipated. Central bank base rates determine the interest commercial lenders receive for depositing money with them. In turn, this affects the rates those banks charge on loans and savings, and influences the wider market for bonds.

Inflation has remained stubbornly high this year, having surged after the Covid pandemic and Russia’s invasion of Ukraine. Meanwhile, economic growth has been more resilient than expected, despite the most aggressive round of interest rate increases in decades from central banks.

Investor appetite for bonds also depends on supply and demand. The economic shock, leading to ballooning government budget deficits, has boosted the number of bonds issued to finance them. Central banks have also stopped buying debt through their post-2008 quantitative easing programmes, including the Bank of England actively selling bonds it holds on its balance sheet to investors.

Most developed central banks have warned interest rates would need to remain at “higher for longer” levels to tackle inflation, including the US Federal Reserve and the Bank of England, although many investors had been betting that rate cuts would be required sooner, as inflation fades and the risk of recession mounts in several advanced economies.

However, figures from the US economy this week suggest a more resilient outlook than anticipated, including in the jobs market – reinforcing the prospect of higher-for-longer interest rates. Oil prices have also risen sharply in recent months to almost $100 a barrel, posing renewed inflationary pressures.

skip past newsletter promotion

Why does it matter?

Higher bond yields push up governments’ debt servicing costs, with a potential impact for tax and spending decisions. In the UK, the rise comes as the chancellor, Jeremy Hunt, prepares for next month’s autumn statement amid demands from Conservative MPs for tax cuts, and as public services come under pressure.

A year ago turbulence in the UK bond market led to the downfall of Truss as prime minister. Global bond yields had been rising at that time. However, the UK was an international outlier, with larger moves than for other advanced economies.

Higher yields are expected to slow the economy, because they will raise the cost of borrowing for businesses and households – weighing on company investment and consumer spending.

Companies with high debt levels could come under greater strain, while there could be pressure in the financial system. Earlier this year rising bond yields led to problems for medium-sized US banks, including the failure of Silicon Valley Bank.



READ SOURCE

This website uses cookies. By continuing to use this site, you accept our use of cookies.