Australian government bond yields have risen to more than two-year highs over the past week, as consumer inflation kicks in across the country.
In the three months to September, the consumer price index (CPI) - which measures household inflation and includes statistics about price changes for categories of household expenditure - rose by 0.8 per cent.
It has been pushed upwards by the costs of construction, home building and fuel, and the annual CPI inflation rate has risen to 3 per cent as a result.
This news has seen bond yields rise - but if your mind struggles to comprehend what exactly a ‘bond yield’ is and what this all means, you’re not alone.
What are bonds and bond yields?
As the Reserve Bank of Australia outlines, a bond is a loan made by an investor to a borrower for a set period of time in return for regular interest payments.
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The time from the bond’s issue to the date the loan is to be paid back is known as its term to maturity, and these terms vary, from one year to several decades.
There are two types of bonds: government and corporate. The government is the borrower in the former, a business or a bank is the borrower in the latter.
A bond differs from a regular loan because a bond can be traded with other investors in a financial market, giving them a market price and making them similar to regular securities.
Bond yields are the returns an investor receives annually over its term to maturity.
The reason bond yields are in the news is because all Australian government bonds have risen on the back of the inflation news.
What is happening with bond yields and why?
Christopher Thomas, director at FIIG Securities, said the rise in bond yields followed an extended period of low inflation and interest rates.
“We have had about 15 years of central banks pumping out a lot of free cash and there has been a lack of consumer price inflation, whilst at the same time we have seen significant asset price inflation,” he explained.
“Last year, people were looking favourably at bonds as a form of disaster insurance, and any yield was a good yield. Now, we’re looking at things with more optimism as we reopen after COVID.”
Thomas said the inflation increase, after many years of calm and low rates, was causing a stir in financial markets, though he said it was impossible to predict whether the rise in inflation would be sustained or a blip on the radar.
“These inflation effects may be transitory, and central banks seem to be looking at it that way,” he said.
“But if we get a meaningful, harder-to-suppress rise in inflation, and supply bottlenecks, lack of immigration, and free cash from central banks continue, that could lead to a more sticky effect in rising bond yields.
“We’re talking about a rise of 1 per cent to 2 per cent, so it isn’t catastrophic, but the level of government indebtedness gives us pause, because we’ve never had this much debt before.”
What does this all mean for the average punter?
There’s no doubt that rising inflation, CPI and bond yields are making some people nervous.
Currently, interest rates are at all-time lows, and the RBA has sought to assure Australians they will remain that way until 2024.
But the rise in inflation is giving people pause - and there’s a whole generation of Aussies out there still scarred from memories of repaying mortgage loans in the 1980s and 90s, when interest rates rose to nearly 18 per cent.
“People are fear-driven,” Thomas said.
“What worries people is that when there are stock market sell-offs, they are used to thinking that bonds are a safe haven, but if inflation rises, they aren’t a safe haven.
“What it means for the average punter is just to be more careful about leverage. We’ve seen people double down in property investment and people have felt further share price rises are immutable because inflation has gone forever, but we’re not sure if this rise will be transitory or more sticky.
“Now is a time to be more cautious.”
Rising bond yields also has a flow-on effect to other parts of the financial market.
Already, the surge in bond yields has sent the ASX lower as investors look on warily at the prospect of rising interest rates.
And this story is not just playing out in Australia, but worldwide. Expectations are growing, for example, that the Bank of England could increase interest rates to offset rising inflation.
Rising interest rates off the back of rising inflation means higher costs for fuel, food and energy, and could see mortgage repayments increase for those on fixed-rate loans.
“It is a trickier time for debt,” Thomas said.
“Inevitably the cost of money goes up, mortgage rates go up and it’s possible you get that feeding into a lower level of property prices.
“It’s a delicate balancing act for central banks following years of pumping free cash into the market.”