What the global bond market turmoil means for consumers

The global bond market is in turmoil again. Investors have been prompted to sell off as they re-price the risk due to concerns that interest rates may remain high for longer, as central banks struggle with persistent inflation .

Analysts believe that a “slow-motion train wreck” on the bond market will lead to a prolonged period economic distress.

Black Monday, the 1987 stock market crash, is a real threat, say experts.

The benchmark US 10-year borrowing cost has risen by nearly 50pc in the last six months. In the UK, 30-year gilt yields have reached their highest level since 1998.

Italy and Germany are experiencing yields that have not been seen for more than 10 years. Not even Japan is immune to this upward trend.

The S&P500 on Wall Street has fallen almost 6pc over the last month. The FTSE 100 index in London also has been flat over the last four weeks.

Bill Blain is a market strategist with Shard Capital. He feels a sense deja vu.

He claimed that the financial markets are now experiencing an “existential crises”, which “might only be momentary or not”.

Mr Blain continued: “Bond rates are increasing on the expectation that they will continue to rise for longer. Markets are worried about debt, currency stability, and politics. “I can’t stop but think back – we’ve been here before.”

Inflation and interest rates are rising, which is eroding the value of government bond values.

Bonds become less appealing due to the possibility of prolonged inflation. Yields rise as bond prices fall.

The Federal Reserve may have to increase interest rates in order to keep up with the tight job market.

Because of the strength of the largest economy in the world, traders believe that interest rates will continue to rise.

Higher debt interest payments are a result of rising government bond yields.

Before UK borrowing costs began to rise, the cost of borrowing was low.

Jeremy Hunt received the OBR’s first verdict on the economy in the run-up to the Autumn Statement.

On Wednesday, his first prediction about how this will affect the public finances arrived in his email.

His comments during the Tory Party Conference suggest that he is aware of money’s tightness, since he stated that tax reductions have become a “academic discussion”.

He told a group of conference attendees that “our debt interest payments are so high in the last 6 months, I don’t think we have much headroom for anything [big].”

Sir Charlie Bean estimates that Britain’s interest costs will increase by around £20bn as a result of the increased borrowing.

Hunt will lose the £6bn he had to reach a debt-reduction target.

Homeowners will experience mixed results from higher bond yields.

Andrew Wishart, Capital Economics, says that will first stop the mortgage rate from falling further.

He says that the impact of the mortgage market on the rate-fixing period will vary.

The highest bond yields have been those with a long-term maturity, as the expectation that rates will remain higher longer has driven the increase.

“As a consequence, the swap rate for the five-year period has changed more than that of the two-year period,” said Mr Wishart.

Five-year swaps that are used to determine the price of fixed-rate five-year loans have increased from 4.4pc to 4.7pc in just two weeks.

Mr Wishart stated that this would increase the interest rate on fixed-term contracts of five years compared to those of two-years.

The borrowers will suffer a particularly heavy blow, as five-year contracts were among the most affordable on the market.

Moneyfacts reported that the average rate for a two-year fixed-rate mortgage on Wednesday was 6.46pc and the average rate for a five-year mortgage was 5.96pc.

If the rise in mortgage rates is sustained, the monthly cost of a typical £200,000 loan would increase by £37.

This is not always the case, as there are variations among lenders.

Brokers say that some large banks have room to make more marginal cuts, because they were slow in responding to the drop in swap rates in summer when higher than expected inflation data caused a surge in expectations of interest rates.

HSBC has announced that it will reduce fixed rates starting Thursday. The move follows recent rate cuts by Coventry, NatWest, and Nationwide.

Nick Mendes of John Charcol mortgage broker said that there is still room for further reductions. The current fixed rate margins still heavily weigh against swap rates that were higher one month ago.

The stock markets do not represent the economy.

Simon French, chief economics at Panmure Gordon , says that prolonged turmoil will affect consumers.

He said: “If this tightening is seen in consumer and business lending then it will make the outlook less favorable.” It is a mistake to believe that it is only affecting the financial markets.

He also adds that the Bank of England may not need to increase interest rates to squeeze the economy. Rates are already at 5.25pc.

Ben Gold, the head of investment for consultancy XPS Pensions says that the increase in borrowing costs on long-term is unlikely to pose a threat to pension funds as they did a few months ago.

The so-called Liability-Driven Investment (LDI), which act as insurance policies during periods of low interest rates, plunged this sector into crisis after borrowing costs rose dramatically.

The sudden increase in funds’ value after the mini-Budget last year brought them to the edge of bankruptcy. But Mr Gold claims that funds now have more collateral to cover cash calls.

Before the crisis, LDI fund averages held enough collateral for yield increases up to 2.5pc. “Now that’s more like 4pc.”

Gold warns that central banks are not yet able to control inflation.

He added: “There is also a question mark as to whether the interest rates have peaked. There is a lot of government debt, and the central banks are also trying to sell bonds that were amassed in the financial crisis. This alone will increase yields.