Bond yields are rising again – here’s why investors should care

The bond market has dominated market discourse in recent weeks as yields on government debt have surged higher.

This has put pressure on equity markets and prompted a surprise intervention from the US government, but what exactly is going on and why is it important to investors?

What is happening?

As a reminder, bonds are IOUs issued by governments, companies and other institutions which usually pay a fixed rate of income, with the principal returned at the point of maturity. The yields on government bonds have increased sharply, particularly on longer-term bonds.

The so-called ‘yield curve’ plots the yields of bonds with different maturities. While typically this would slope upwards, to compensate holders for the extra risk scope for things to go wrong over the longer lifespan of the debt, the slope has got steeper since mid-August.

Or in other words, the yields on 10-, 20- and 30-year debt have risen faster than those on short-term yields. In the US the 30-year yield rose to its highest level since 2007 above 5.3%.

Why are government bond yields rising?

The yield on a bond rises when the price falls, and, like most assets, the price is a function of supply and demand. Government bonds are in less demand thanks to the sheer scale of borrowings (with US national debt ticking over $40 trillion), rising deficits (the shortfall between the amount a country spends and how much it brings in in revenue) and concerns about inflation thanks to the crisis in the Middle East.

Mounting inflation is bad news for bonds because they mostly offer a fixed rate of return whose value is eroded by rising prices. These factors are compounded by reduced purchases of government bonds by central banks.

On the supply side, not only is the amount of debt being issued by governments continuing to go up but there’s now competition from big technology companies which are launching their own substantial bond issues as they look to fund massive spending on AI.

Why are rising yields bad for stocks?

As well as being a headache for governments trying to fund public services and their other spending, rising bond yields are typically bad news for equity markets too for two key reasons. One is they increase the cost of companies’ own borrowings which eats into their profitability.

The other is that when the yields on low-risk government bonds are higher they compare more favourably with the higher-risk stock market, making the latter a less attractive place for people to put their cash.

What did the US Treasury do and what impact did it have?

To stem the selling in bonds, the US Treasury Department announced plans to double its purchases of 10- to 30-year bonds from $2 billion to “at least” $4 billion. While a modest sum in the context of US borrowings of $40 trilllion, this signal of intent was enough to drive yields lower for a short period.

However, subsequently yields went back up and the US dollar fell. This move in the currency was linked to a perception that Washington is seeking to prevent bond yields from rising naturally.

• Read: Can gold keep shining?

Gold prices rose, partly thanks to the precious metal being denominated in dollars (with the weaker currency making it cheaper for non-dollar buyers) and partly thanks to attributes which have been prized for centuries. Gold has no credit risk and cannot be created by a government or central bank. As such it is seen as an alternative store of value when there are concerns about government actions having a disruptive impact on the bond and currency markets.