News

Government debt is rising, particularly in established industrialised nations, whilst interest rates are on the rise. The yield on 30-year US government bonds has now returned to around 5.2 per cent. This is putting pressure on public finances. “However, the bond market is not signalling a new crisis, but merely the end of an exceptional period,” says Thorsten Fischer, Managing Director and Head of Portfolio Management at Moventum AM.

In the US, gross government debt has exceeded the US$40 trillion mark for the first time. At the same time, the yield on 30-year US government bonds temporarily reached its highest level since 2007. This is also causing interest rates to rise elsewhere. “What at first glance appears to be a new debt or bond crisis is, on closer inspection, primarily a return to a historically more normal level of interest rates,” explains Fischer. It is becoming clear that the exceptionally low yields of the past 15 years were not a sustainable ‘new normal’, but rather a historical exception.

During the 2010s, there was a structural excess demand for safe bonds in the markets. Central banks, commercial banks and pension funds purchased government bonds on a large scale for regulatory and strategic reasons. “This environment has now changed fundamentally,” said Fischer.

Pension funds are increasingly investing in shares and private assets. Deglobalisation is reducing the need for foreign exchange reserves, whilst foreign investors are focusing more on returns and less exclusively on safety. At the same time, government deficits remain high and debt continues to rise. The result: a growing supply of bonds is meeting less elastic demand. Increased uncertainty and long-term inflationary and fiscal risks are also pushing up interest rates.

“Unlike share prices, bond yields tend to converge towards a mean over the long term,” says Fischer. This mean has fallen over decades, but cannot fall indefinitely. “Human time preference and uncertainty about the future set limits on a sustained decline in real and nominal interest rates.” A return to higher yields is therefore not automatically a sign of a failure of the financial system. Rather, it can be understood as a normalisation of a historically unusual and favourable financing environment.

Even central banks, which primarily control short-term interest rates, are powerless to counter this. Yields at the long end, by contrast, are largely determined by the market: by inflation expectations, growth, government debt and the balance between supply and demand. “Bond purchases or other forms of market intervention can, at best, only temporarily influence the long-term yield curve,” explains Fischer. This is also demonstrated by the US Treasury’s latest attempt to calm the market by expanding its bond buy-back programme – without any lasting success.

Japan once again illustrates the damage that persistently very low interest rates can cause. Decades of interest rate caps led to market distortions there; ‘zombie companies’ were kept artificially alive, and the necessary market consolidation failed to materialise. The consequences are low growth and a conflict of objectives between combating inflation and maintaining currency stability.

“Anyone who wants to keep long-term interest rates low in the long term,” said Fischer, “has no choice but to undertake credible fiscal consolidation.” This realisation has been increasingly ignored over the past two decades. Rising yields are now bringing into sharp focus the costs incurred by growing debt. In the US, annual interest payments now amount to more than one trillion US dollars. Debt servicing has thus become the third-largest item in the federal budget.

This has consequences for the private sector: whilst savers are receiving better returns, loans are becoming more expensive at the same time. In the US, the average interest rate on 30-year mortgages currently stands at around 6.7 per cent. “The corporate sector is also coming under pressure,” says Fischer. Companies that took on debt on particularly favourable terms before the pandemic now have to refinance maturing loans at significantly higher interest rates.

A mixed picture for investors too:
• Long-dated bonds are once again offering a genuine term premium and may therefore become more attractive for strategic portfolio construction.
• At the same time, risk is rising for over-indebted companies and interest-rate-sensitive sectors. Balance sheet quality and refinancing capacity are coming more into focus.
• Those seeking security in government bonds must increasingly expect higher yields as compensation for a growing supply.

“The transition to higher interest rates may be bumpy in the short term,” said Fischer. In the long term, however, it could lead to greater fiscal discipline, more realistic pricing on the capital markets and greater transparency regarding the costs of government debt.