A significant sell-off in the global bond market is driving up borrowing costs for governments worldwide, with ripple effects that could lead to higher mortgage rates and diminish returns for superannuation funds.
The international bond market, where investors demand higher returns for lending money, is experiencing a significant downturn. This trend is pushing up yields on government bonds, including Australia's 10-year government bond, which has reached a 15-year high of approximately 5.2 percent. This contrasts sharply with the pandemic low of 0.55 percent.
This global phenomenon is not confined to Australia. Yields in the United States, Japan, Britain, and continental Europe are also at multi-year highs. Investors are reacting to persistent inflation, substantial government deficits, and central banks maintaining higher interest rates for extended periods. The Organisation for Economic Co-operation and Development (OECD) estimates that governments and corporations will raise a record $29 trillion from bond markets this year, double the amount borrowed a decade ago.
Impact on Borrowing Costs
A bond is essentially a loan made by an investor to a borrower, typically a government or corporation, which promises to repay the principal along with interest over a set period. Bond prices and yields move in opposite directions: when demand for existing bonds falls, their prices drop, and their yields rise. Governments issuing new bonds must then offer these higher yields to attract investors, thus increasing their borrowing costs.
For Australia, which has a gross debt hovering around $1 trillion, maturing bonds being replaced at these new, higher rates will significantly increase the government's interest bill. Every dollar spent on servicing debt is a dollar that cannot be allocated to public spending or tax relief, potentially forcing governments to either cut spending or raise taxes.
Effects on Households and Businesses
While the cash rate set by the Reserve Bank of Australia (RBA) is the primary driver of variable mortgage rates, rising global yields put upward pressure on new fixed mortgage rates. More critically, higher bond yields signal investor expectations that the RBA may need to keep interest rates elevated to combat inflation. This can lead to mortgage holders facing increased costs from both the RBA and international market forces.
For a $600,000 principal and interest mortgage with 25 years remaining and a starting rate of 6 percent, a one-percentage-point increase in interest rates would cost approximately an additional $4,500 per year.
Businesses also face challenges. Higher safe returns on bonds can make them a more attractive investment compared to equities or other assets, potentially pressuring share and property values and thus affecting superannuation balances. Investment may stall, and hiring could slow as businesses face increased borrowing costs and uncertainty.
Australia is not facing an imminent sovereign default, as its debt-to-GDP ratio is relatively strong compared to many international peers. However, the sustained pressure from higher borrowing costs, reduced asset values, and a growing portion of tax revenue directed towards interest payments presents a significant economic challenge. To mitigate the impact, governments may need to exercise fiscal restraint, reducing borrowing during periods of elevated global costs.