Paris: Governments face a rise in their borrowing costs due to the winding down of monetary stimulus programmes and as investors bet on central banks hiking interest rates sooner than promised.
Moody’s Analytics warned this week that “US rates could rise as the Fed moves to slow its purchases of long-term debt, which in turn could push up the yields on European government bonds.”
That has already begun.
The yield on the debt of the United States and top European countries, as well as emerging economies, has risen recently as investors bet that the US Federal Reserve could begin as soon as in September to lower the amount of monetary stimulus it injects into the economy.
The $85 billion (€64 billion) per month that the Fed has ploughed into the US economy led to lower bond yields in the United States, as well in many other countries as easy money went abroad from the United States in search of somewhat higher risk and yields elsewhere.
But recently, investors have factored in the prospect of the easy money tap being slowly closed down. This has pushed up yields on US Treasury bonds, and has caused some of the money placed abroad to be withdrawn, pushing up sovereign bond yields elsewhere.
The rate of return for investors on 10-year US Treasuries rose to 2-year highs this past week, implying a more than 50 per cent increase in US borrowing costs since the beginning of the year.
On Friday, 10-year Treasuries were trading at 2.812 per cent, up from 2.689 per cent at the beginning of the month and 1.828 per cent at the beginning of the year.
Ten-year British gilts were at 2.704 per cent Friday, up from 2.401 per cent at the beginning of August and 1.990 per cent at the beginning of the year.
At the height of the Eurozone debt crisis, some Eurozone money flowed into less risky bonds, such as French debt. But as the debt crisis eases, bond yields for the countries in trouble have fallen and there are signs that yields on the safe haven countries may rise, with French bonds being closely watched.
For Germany, the yield on 10-year Bunds was 1.881 per cent on Friday, up from 1.667 per cent at the beginning of the month and 1.442 per cent at the beginning of 2013.
France’s 10-year bonds yielded 2.400 per cent Friday, up from 2.223 per cent at the beginning of August and 2.077 per cent at the beginning of the year.
The drop in sovereign bond yields to exceptionally low levels, thanks to the ultra-low interest rates set by central banks and huge monetary stimulus programmes, have masked the debt problems the countries face.
Now their governments face having to pay more to finance new debt as their borrowing costs rise in line with the yields on the secondary market where debt issued previously is traded.
The rise in sovereign yields has come even though central banks have pledged to keep those near-zero rates for the foreseeable future.
Bond analyst Rene Defossez at French investment bank Natixis said investors are starting to bet that the signs of economic recovery which justify the winding down of stimulus may induce central banks to raise rates sooner than they suggest.
“The factors which are pushing yields higher are tending to prevail” over the interest rate guidance issued by central banks.
This was particularly marked in Britain this week as the minutes from the last policy meeting of the Bank of England revealed some disagreement over its forward guidance.
Governments living on ‘borrowed time’
And there has been an unexpectedly strong rebound by European economies in the second quarter — 0.6 per cent in Britain, 0.7 per cent in Germany and 0.5 per cent in France even though analysts warn that in France a big factor was bad weather and consumption of energy for heating.
“The prolonged period of exceptionally loose monetary conditions in the UK and other parts of the developed world is on borrowed time,” analysts at London-based Capital Economics said this past week.
“We therefore think that real long-term yields are likely to drift up over the next few years as the monetary screws are slowly tightened.”
This is encouraging those who hold long-term bonds to sell while bond prices are still relatively high.
Bond prices and yields move inversely.
Those investors who bought bonds in the past couple of years when yields have been low acquired them at a high price.
Thus the expectation that yields will rise means the price of bonds will fall.
In historical terms, the current price of bonds of the major countries is “very, very expensive”, according to Defossez.
“The potential for the price of the Bund to fall is colossal,” he said.
Another factor likely to bear on investment decisions is relative changes in exchange rates which are highly sensitive to interest rates, and to the size and cost of national debt.
The prospect of outflows of capital because of US policy have pushed the Indian currency down sharply in recent days.