Sell-off

There is widespread turmoil. In recent months, a veritable sell-off has taken hold in the bond market. This can be seen in the yields on government bonds with terms to maturity of ten years or more. The yield indicates the total return that can be achieved on a bond at the time of purchase. The higher it rises, the lower the price of the bond has fallen.

In the US, for example, the yield on ten-year government bonds has risen by just under one percentage point since the start of the year to around 5 per cent. This means that if the US were to borrow money on the financial market today for a ten-year term, it would have to pay 5 per cent. The picture is the same in France: here, the yield on ten-year government bonds has risen by around 1.5 percentage points to 5.1 per cent.

That may not sound like much. However, if the government is already running a deficit and interest rates on debt are rising, then savings must be made elsewhere to an even greater extent. But what does this mean for investors, and why have market interest rates moved in this way?

Attempts at an explanation

No one can say with absolute certainty why the sell-off took place. Every day, millions of investors worldwide make portfolio decisions for various reasons. No one goes round asking them all why they did this or that. Yet, broadly speaking, there are two explanations – one positive and one negative.

Firstly, investors are shunning government bonds because economic growth this year is proving stronger than expected. Energy prices have risen since the war in Iran began. But although the consequences of this affect everyone in an economy, it has not had a major impact so far. When an economy grows rapidly, it is likely that price pressures will increase. Consequently, the central bank raises interest rates to prevent the economy from overheating. Investors therefore anticipate higher inflation and demand higher interest rates. At the same time, in a growth environment, equities are more attractive than bonds.

Secondly, investors are once again taking a closer look at governments’ debt ratios. In many countries – particularly the US and France – expenditure exceeds revenue year after year. Because it is politically unpopular to tighten the belt or raise taxes, these governments simply take on more debt on the bond market. The more debt they accumulate, the more uneasy lenders feel, so they demand higher interest rates.

And the consequences?

Whatever triggered the sell-off: interest rates are where they are. There is no point in lamenting it. Investors must now ask themselves how to deal with this. Firstly, they have felt the impact of lower government bond prices on the overall return of their portfolio. However, these losses are, for the time being, only on paper. This is because government bonds will almost certainly be repaid at maturity, with interest.

For new investments, the lower prices – and, conversely, the higher yields – may be attractive. Of course, it takes some resolve to buy precisely those bonds that have lost value. It is the recurring dilemma: what if prices fall even further? Yes, nobody can rule that out. However, the higher current interest income acts as a buffer to absorb any potential further losses.

In short: these are tough times for those in need of credit. Lenders and investors, who can buy bonds offering better yields, stand to benefit.

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