A bond acts as a loan given by investors to a borrower, typically governments, corporations, or other entities, to raise funds. The global bond market, valued at nearly $130tn, stands as the largest securities market, with the US bond market constituting about 40% of global debt. Bond yields, indicative of the earning an investor gets from holding the debt, inversely relate to bond prices and often mirror interest rates or the “borrowing cost” for issuers.
Rising bond yields reflect a reduced willingness among investors to hold the debt, affected by various factors such as the issuer’s repayment capability, economic outlook, and national fiscal health. Inflation expectations significantly impact bond yields since inflation erodes the future value of the debt’s returns, leading investors to seek higher yields as compensation.
The swift ascent in government bond yields has triggered unrest across a range of asset classes, with notable effects on the corporate credit sector. The spread on investment-grade bonds broadened, junk bonds experienced a dip, and certain planned issuances were abandoned. The mortgage-backed securities market, valued at $8 trillion, is on a descent towards a record trough, hinting at an increase in US home loan rates, which recently hit over 7.5%. Over in Europe, the downturn in Germany’s property market saw its first casualty, and a substantial sale of European leveraged loans was put on hold. The rise in yields propelled a rally in the US dollar, disrupting the positive narrative for emerging-market assets. As the yield on debts outstripped the yield on earnings, a warning was sounded in the equities market of developing nations, a scenario nearly replicated in the US stock market.
A substantial sell-off in world government bonds occurred on Wednesday, pushing U.S. 30-year treasury yields to 5% for the first time since 2007 and German 10-year yields to 3%. This could hasten a global economic slowdown, impacting stocks and corporate bonds. The situation is spurred by the anticipation that major economies will maintain higher interest rates to control inflation. The sell-off, accentuated by incorrect market positioning, also affected UK, Australian, and Canadian bonds, causing concern across equity markets and bolstering the U.S. dollar against other major currencies. The sell-off reflects a shift in investor sentiment, expecting longer periods of heightened interest rates amidst strong U.S. economic data.
IMF chief, Kristalina Georgieva, said that improved demand for services and progress in reducing inflation may help the global economy avoid a recession. However, fiscal and financial risks persist. Since 2020, successive shocks have cut $3.7 trillion from global output, and current growth lags behind pre-pandemic levels. Persistent inflation necessitates higher interest rates for longer, adversely affecting emerging and developing economies.
Would it be stagflation the next phase in the economic cycle?
