Posted in: Ideas in Finance

Why Bond Yields Are in the News

Although the global bond market is actually a little bit bigger than the global stock market (around $160 trillion vs around $158 trillion), nobody talks about it. Bond markets are like plane rides. They are either very boring or very scary. When they get scary, people start to notice. As we mentioned in previous posts, interest rates tracked a steady long-term decline from 1980 to 2022. Not surprisingly, asset prices, especially shares and housing, tracked a steady long-term rise. Bond yields appear to have bottomed in 2022 and have been moving higher since. Most of the public’s attention is on the central banks, like the Reserve Bank of Australia (RBA), with most people assuming (and the media reinforcing this assumption) that the central bank controls the interest rate. They don’t. There isn’t a single interest rate to control. Central banks can influence the very short-term rate with the conventional measures at their disposal. This influence does not automatically extend to all the interest rates that prevail at any given time in the economic system: one-year rates, two-year rates, … 30-year rates.

While the central banks around the world have been increasing short-term rates in response to higher inflation, the more important move has been at what economists call the long end of the yield curve. That is, interest rates on 10-year and 30-year government bonds. The yields on these have been rising. The Australian government 30-year bond now yields almost 5.70%. The 10-year Australian government bond yields almost 5.20%, the highest since 2011. In many countries, including the UK, France, Germany, Japan, and the United States, government bond yields are hitting heights not seen in decades. Why is this important?

One reason this is important is that governments are heavily indebted and running deficits each year (i.e., getting deeper in debt by the day). They need to keep borrowing. Higher yields make it more expensive to service the huge debts they are accumulating. Government debt is now $1 trillion in Australia. For many governments, interest repayments are now one of the largest budgetary expenditures, meaning that most government spending goes on Medicare, social security, defence, and interest payments. In America, the interest bill is now more than defence spending per annum. The interest on Australia’s debt is more than $40 billion a year, rivalling defence spending ($60 billion) and the NDIS ($55 billion).

Governments seem unable to get spending under control which means they are kind of like the person they warn you not to become when you’re a kid. That is, someone who is paying off one credit card with another. Obviously, this places government finances under pressure and restricts what governments can do, especially if there is another crisis of some sort. Since government spending has, as we have pointed out in previous posts, become a very large percentage of GDP, high interest payments certainly raise a spectre of broader economic problems if they lead to government spending cuts in other areas. Large parts of the economy depend on government spending. But this is not the only reason why people are worried about rising bond yields. There’s a bigger and scarier reason.

In the financial system, government bond yields are considered to be the risk-free rate of return. Everything else is benchmarked against this risk-free rate. One needs only basic commonsense to see what’s going on. If you can expect a yield of 2% risk-free, you might be willing to accept 5% by putting money at risk, in the stock market, say. But if you can earn 5% risk-free, you’re no longer willing to accept 5% for bearing risk. You’ll want 8%, say. The only way that the stock market can meet your new requirement is for free cash flows generated by companies to rise enough to justify the current prices. Since that is unlikely, the other way the requirement for a higher return can be met is for prices to fall. Assume you hold a stock that trades at $10 and has a dividend of $0.50 (i.e., 5%). If you now need 8%, the dividend has to go to $0.80, or the price must fall to $6.25 (to make the $0.50 dividend 8% instead of 5%). Notice how much the stock price falls in this example: by 37.5%.

The same holds for every asset in the economy. You might be happy with a rental property that yields 4% when the risk-free rate is 2% but if the risk-free rate is 5%, you need a much higher return than 4% on the rental property. Either the rents must go up, or the house prices must come down. Likewise for banks lending into the mortgage market. Banks can’t make risky loans at rates that are below the risk-free rate. No bank CEO would last very long doing that. For one thing, banks usually securitise and sell the mortgages they write, and no investor will buy mortgage-backed securities at 5% when they can get that yield risk-free on government bonds. So, mortgage rates must rise too.

This is making news because the effects can be quite dramatic. If bond yields keep rising, the whole risk-reward trade-off must be recalibrated. There is, interestingly, another perspective which is, if anything, bleaker. If inflation and worries over government finances are biting so hard, why haven’t bond yields risen more? After all, there is a long way to go to get back to historical averages. The explanation might be that markets are reflecting a much more problematic economic picture: recession. If the economy is going well, higher oil prices may push inflation higher, which would then push interest rates up. But what if the economy is actually doing poorly and will perform even worse in the next few years? This could explain why oil prices didn’t surge even more during 2026. In an economic slowdown, less oil is needed. And if people are losing their jobs, there is less pressure on prices. This alternative explanation, which fits some aspects of the economic data picture, is worth considering.

Why Bond Yields Are in the News

Read more Ideas in Finance

About Us

Higher Education

Professional

Vocational

Schools

Support & Contact