Govt bonds are borrowing instruments. High interest rates means more deficit

When a bond yield rises, its price falls

LONDON (Reuters/Web Desk) – Pakistan has issued government bonds offering a high return. But the high interest rates mean the government is paying more to the investors, further burdening the exchequer amid the current financial crisis. The following latest Reuters story has explained what is the current situation and its consequences globally.

WHY A ROUT IN GOVERNMENT BONDS IS WORRYING?

The world's biggest bond markets are in the throes of another rout as a new era of higher for longer interest rates takes hold.

In the US Treasury market, the bedrock of the global financial system, 10-year bond yields have shot up to 16-year highs. In Germany, they touched their highest since the 2011 Eurozone debt crisis. Even in Japan, where official rates are still below 0 per cent, bond yields are back at levels seen in 2013.

Because government borrowing costs influence everything from mortgage rates for homeowners to loan rates for corporates, there's plenty of reason for angst.

Here's a look at why the bond rout matters.

1. WHY ARE GLOBAL BOND YIELDS RISING?

Markets are increasingly reckoning with interest rates staying high.

With inflation excluding food and energy prices elevated and the US economy resilient, central banks are pushing back against rate cut bets.

Traders now see the Fed cutting rates to only 4.7pc from 5.25pc-5.50pc currently, up from the 4.3pc they anticipated in late August.

That's compounding worries about the fiscal outlook following August's Fitch US rating downgrade citing high deficit levels. Highly-indebted Italy raised its deficit target last week.

Higher deficits mean more bond sales just as central banks offload their vast holdings, so longer-dated yields are rising as investors demand more compensation.

Many investors were also betting bond yields would drop, so are extra sensitive to moves in the opposite direction, analysts say.

2. HOW FAR COULD THE SELLOFF GO?

US data remains resilient with Monday's upbeat manufacturing survey pushing Treasury yields up again. That is no surprise, and analysts do not rule out a rise in 10-year Treasury yields to 5pc, from 4.7pc now. When a bond yield rises, its price falls. But Europe's economy has deteriorated, so selling should be more limited there, as bonds typically do better when an economy weakens, and most big central banks have signalled they are done with rate increases. Germany's 10-year yield, at 2.9pc, could soon hit 3pc – another milestone considering yields were below 0pc in early 2022. 3. WHY DOES IT MATTER AND SHOULD WE WORRY? US 10-year Treasury yields have risen to their 230-year average for the first time since 2007, Deutsche Bank data shows, highlighting the challenge of adjusting to higher rates. Bond yields determine governments' funding costs, so the longer they stay high, the more they feed into the interest costs countries pay. That's bad news as government funding needs remain high. In Europe, slowing economies will limit how much governments can unwind fiscal support. But higher yields are welcome to central bankers, doing some of their work for them by raising market borrowing costs. US financial conditions are at their most restrictive in nearly a year, a closely-watched Goldman Sachs index shows. 4. WHAT DOES IT MEAN FOR GLOBAL MARKETS? The ripple effects are broad. First, rising yields set the stage for a third straight year of losses on global government bonds, hurting investors long betting on a turnaround. As for equities, the bond yield surge is starting to suck money away from buoyant markets. The S&P 500 is down roughly 7.5pc from more than one-year peaks hit in July. Focus could turn back to banks, big holders of government bonds sitting on unrealised losses, a risk put on the radar by Silicon Valley Bank's March collapse. "(The bond selloff) will have a strong impact on banks that hold long end Treasuries," said Mahmood Pradhan, head of macro at Amundi Investment Institute. "The longer it persists the more sectors it will hit." Higher US yields also mean an ever stronger dollar, piling pressure on other currencies, especially Japan's yen. 5. SHOULD EMERGING MARKETS BE WORRIED? Yes. Rising global yields have ramped up the pressure on emerging markets, especially higher-yielding riskier economies. The additional yield junk-rated governments pay on their hard-currency debt on top of safe-haven US Treasuries has risen to over 800 basis points, according to JPMorgan, more than 70 bps higher from their Aug 1 trough. "The intensification of the higher-for-longer narrative, along with the rise in oil prices, has also been the primary driver of broad US dollar strength," said Andrea Kiguel, head of FX and EM macro strategy, Americas at Barclays. "The speed of the move has led to weaker currencies within the region, a violent sell-off in local rates and wider EM credit spreads."