Ah the US 10-year Treasury bond – an eye-glazing financial product if there ever was one. Or is it?
Prepare to be surprised, because few people know what this magical bond does, and what it means.
The 10-year Treasury bond is a debt security, issued by the US government. Importantly though, it’s also a bit of a bell-whether for where interest rates are heading – globally.
What do I mean by that? It’s pretty simple: a few weeks back global financial markets got into a tailspin because of data showing wages, and hence inflation, might be starting to pick up in the US.
That means higher interest rates. We know the Federal Reserve uses higher interest rates to control the spread of inflation (kind of like putting water on a fire), but we’re still waiting for it to make its next move.
While economists and commentators can predict as much as they like about how many times “The Fed” might raise rates this year (without really knowing), the interest rate on the 10-year bond is already moving – and it’s moving higher!
So… what’s the significance of this 10-year bond yield rising?
Speed is the key
One aspect of the rising 10-year bond yield I haven’t mentioned yet, and it’s sort of critical, is that the interest rate on the bond is approaching 3 per cent. Now while 3 per cent is a round number, it’s also a level the interest rate hasn’t surpassed since 2014.
The consensus at the big end of town is that if it approaches 3 per cent, pushes passed it convincingly, and then starts to head toward 4 per cent, markets will … um… freak-out.
UBS Asset Management head of fixed income Anne Anderson, who manages over $30 billion worth of bonds, told me, “Now if it went to 4 per cent, that would be a game changer.”
Now while you could argue interest rates naturally start rising as economies pick up speed, the problem here is that activity has been thus far boosted by so much stimulus, analysts aren’t confident markets can take the higher rates.
Ms Anderson fears it could trigger big falls in property and share prices globally.
“It’s taking us back to levels we haven’t seen for over 10 years,” she said.
“That would mean that monetary policy was tight, and what you should look for next, is the possibility of a recession.”
How it affects your hip pocket
I’ll be blunt, there’s a direct relationship between rising US 10-year Treasury bonds, and rising Aussie fixed rate mortgages. That’s why Anne Anderson’s warning about falls in the property market.
Don’t believe me?
Well independent economist Warren Hogan warns that if the rate on the bond rises towards 4 per cent, borrowers will be squeezed by higher interest rates.
“[The 10-year Treasury bond] is a benchmark for all other interest rates in other countries such as here in Australia.”
But specifically? What does he think? Well he didn’t hold back.
“[There could be] small upward pressure on Australian interest rates and some upwards pressure on the cost of borrowing by Australian organisations and banks overseas, which could filter through to home-lending rates and other rates.”
You might have heard of Shane Oliver too.
He’s the head of investment strategy at AMP Capital and looks after $179 billion in clients’ funds.
Dr Oliver supports Mr Hogan’s analysis.
“The most direct link is to fixed-rate mortgages.”
“If mortgage rates in the US and elsewhere continue to rise like they have then, sooner or later, Australian banks will start to increase their fixed mortgage rates.
Of course higher global interest rates have flow-on effects to share markets as well – as we were brutally reminded of a few weeks back.
The consensus among economists and strategists it that there’s likely more volatility on the way. The basic principle is that if there is an increase in interest rates, share markets will go down.
Shane Oliver explains that this is just part and parcel of investing in risky assets like equity, but he wants to reassure those with stocks that over the long haul, shares do rise over time.
Warren Hogan is a little more circumspect:
“The whole equity market volatility we saw at the end of January was all about rising long term yields, inflation risks and stronger growth.”
“[It was] all pointing to this concern about rising yields.
“[The stock market correction and the recent dip in property prices] really is probably just a taste of what’s to come.”
My message to you
Watch the US 10-year Treasury bond market. It’s currently sitting at just under 2.9 per cent.
The latest US jobs report (out last weekend) – while showing a big lift in jobs, revealed wages growth had slowed. This time around wages grew at 2.6 per cent, not the 2.8 per cent we saw last report. So Wall Street didn’t freak out about a sudden surge in inflation.
However, the 10-year bond yield did rise. Not by much… but it did rise. That would suggest, longer term, traders still believe there’s upwards momentum on rates. The question remains though: how much upward momentum?
Some people like to follow a football team, or a netball competition, or they’re interested in trains, or the weather. I love to watch the markets because they tell you what’s going on in the world, and what might be about to happen next – what’s not to love about that?!