Government bond markets are on a terrible run, with longer term interest rates reaching their highest level in many years.
These bond interest rates – or yields, as they are called – move inversely to prices, with the US 10-year interest rate at 4.8 per cent, the UK yield at 5.2 per cent and German, the euro zone benchmark, with yields at 3.38 per cent, the highest since the euro zone debt crisis in 2011.
The kind of moves seen in recent weeks – and notably over the last seven days – are unusually large and are thus important and worrying signals.
This also means that the Republic has to pay a bit more to raise funds on the market, with €1.25 billion in six- and nine-year Irish debt auctioned on Thursday at a yield or interest rate between 3.23 and 3.41 per cent.
This compares well with debt being issued by other euro zone countries, thought of course is well above the rock bottom rates at which money was raised in the years running up to Covid-19.
As the cost of borrowing edges ever higher, Ireland’s ability to raise money at relatively cheap rates is a key advantage worth fighting to hold on to.
Why is this happening?
The bond market has been hit by higher inflation and the further rise in oil and gas prices this week has added to nerves. Expectations that central banks will hike short-term rates in response has led to a reaction on bond markets – rate increases in the euro zone, the UK and US are all now expected by the markets.
Post-Covid and the energy shocks, many governments also have high levels of borrowings and a significant need to raise funds.
NTMA sells €1.25bn of bonds amid market turmoil
There is thus competition for investors’ cash and governments are having to pay up and offer higher interest rates. Also, the private sector is borrowing more, notably so-called artificial intelligence (AI) hyperscalers, the big tech companies which are raising billions to invest in infrastructure.
They are expected to raise $400 billion (€344 billion) to $500 billion this year alone from bond markets and an estimated $2 trillion by 2030. This also increases competition for funds on the market, pushing up government bond yields.
What does this mean for Irish borrowers?
The latest European Union-wide inflation figures, published this week, showing inflation at 3.3 per cent in August more or less guarantees an European Central Bank (ECB) rate rise next Thursday, even if core inflation – excluding volatile items like energy – remains at a modest enough 2.4 per cent. Short and long-term interest rates do not always follow each other directly, but fears of higher inflation are clearly having an impact in all markets.
The general environment of higher borrowing costs across the board is also of concern to mortgage borrowers.
Higher three- and five-year rates on bond markets could feed through to new fixed rate mortgage offers over the rest of this year as banks price these products in relation to the market. This will concern new borrowers and those rolling off fixed rate loans and needing to decide what to do next.
What does it mean for governments?
Higher bond interest rates increase the price of raising money. Britain’s new prime minister, Andy Burnham, has seen UK ten year interest rates rise by more than 0.10 per cent in recent days to 5.24 per cent, reflecting in part moves on international markets.
Burnham knows he needs to keep investors onside to be able to keep borrowing money and will be mindful of the blowout in markets which ended the premiership of Liz Truss in 2022.
In the US, new Federal Reserve Board chair Kevin Warsh is talking tough in terms of controlling inflation and may hike interest rates. But the key issue for investors is the size of US borrowing and the huge borrowings needed to fund this.
The US deficit is forecast to be an eye-watering $2 trillion this year, or 6 per cent of gross domestic product (GDP) and there is no credible plan to reduce it.
In the euro zone, France is under pressure, with the spread between its borrowing rates and those of Germany moving to their higher level since the financial crisis. With a presidential election next year, investors are concerned that no move to control borrowing will be possible.
Europe looks old and broke to its lenders, but it’s not the only region with problems
“The rise in yields … will put some pressure on governments to place more attention to debt sustainability,” according to Dermot O’Leary, economist at Goodbody” Given the upward pressure on spending in many areas, difficult political choices will be required. ”
A concern would be a sudden loss of confidence in any market – or problems in part of the plumping of the markets which rely on bond rates, similar to what happened in the UK in 2022.
Can the authorities do anything? The US treasury secretary Scott Bessent recently ordered an intervention to buy US bonds, though the scale of it meant it did not make a significant difference. Central banks also try to ensure markets trade in an orderly fashion.
The ECB has a range of tools allowing it to step in and support markets under certain conditions, but would only use them in exceptional circumstances. But fiscal risk is back in the minds of investors and higher inflation and growing economies look set to keep longer-term rates heading higher.
What about the Republic?
The Republic’s strong public finances have gradually built investor confidence since after the financial crash and the bailout. Also, with the budget in surplus – meaning revenues exceed spending – Ireland has had limited need to borrow money on the markets, just doing so to refinance old debt.
The domestic debate is dominated by concerns about the sustainability of this, particularly given the State’s reliance on a few giant US multinationals for tax revenue. But the markets like the headline numbers and debt ratings agencies have gradually pushed up Ireland’s rating.
Today Irish ten year debt is trading at over 3.5 per cent, not too far above Germany at 3.35 per cent and well below France and Italy, both over 4.2 per cent. And new cash for shorter time periods was raised at between 3.2 and 3.4 per cent in Thursday’s auction.
This “safe haven” status at a time when investors worry about public finances in many countries offers precious advantages to Ireland, if it can be maintained. We are moving into a world where raising debt for countries is going to cost more than it did in the long low inflation period in the late 2010s.
By 2019, bond yields were negative in many cases and Ireland sold short term debt at negative yields and even had one longer term issue at just under 0 per cent.
The National Treasury Management Agency (NTMA) did a good job during the period restructuring Irish debt and locking in as much as possible for as long as possible at super-low rates, meaning the average interest rate on all outstanding Irish debt is a low 1.6 per cent.
This is now set to rise in the years ahead – Frank O’Connor, the NTMA chief executive, has estimated that Ireland’s annual debt servicing interest bill will double from around €3 billion a year now to €6 billion a year by 2030.
In a world where attention is back again on fiscal risk, there is a strong case for Ireland fighting to keep its strong reputation to keep access to cash open at the lowest possible rates.
Bossing the bond market never works
And what about equity markets?
Higher bond yields are traditionally a negative sign for equities – for one thing they provide a safe haven for investors at a fixed return, upping the bar for returns they demand from shares. But for now nothing seems to stop the upward march of share markets, driven in large parts by AI investment and expectations.
World economic growth has also proven more resilient than expected despite rising energy costs. Whether higher bond yields – and questions about returns from the massive investment in AI – will be enough to burst the equity bubble is an interesting question. Valuations look vulnerable, but for now the AI hope factor remains.