Insights

We could all pay the price for a hissy fit in the global debt markets

There are rumblings in the global debt market. Investors that have already lent out more than $240 trillion (£180 trillion) are demanding higher interest rates to provide additional funds. Since January the US government has seen the cost of borrowing rise by more than a third. The US Treasury must now pay more than 3.2% on ten-year debt – its highest such level since 2011.

This is not just an American phenomenon. In Britain, the interest rate on new government debt is at its highest level in almost three years. Even in Japan, for years the home of exceptionally low interest rates, there are signs this may be starting to reverse. Having seen interest rates steadily fall around the world for more than thirty years, are we facing an unpredictable and painful rebound?

At this point it is worth noting that we have been here before. In 1994, 1998 and also in 2003 lenders fretted about rising inflation and demanded that borrowers pay more. On each occasion, after an initial period of anxiety, there was a resumption of the steady grind lower in interest rates. Then in 2013 the US Federal Reserve triggered fears that central banks – purchasers of more than $20 trillion of debt since the financial crisis – would bring their buying spree to an abrupt halt. This last episode became known as the “taper tantrum”. Five years on, investors fear a full-blown hissy fit.

There are many reasons for this renewed anxiety. After the false start of 2013, the world’s central banks are set to enter 2019 buying less debt than at any time in the past decade. This comes at a time when the US Treasury is poised to issue $8 trillion more debt to fund the Trump administration’s recent tax reforms. Private investors are expected to step into the breach – and to do so they are demanding higher interest rates. To cap it all, trade spats between the three economic behemoths – the US, China and the EU – has investors fearful that powerful rhetoric may translate into disruptive actions. In short, there are plenty of reasons to be concerned that borrowers may not be good for their repayments.

But why should Times readers care? It is easy to see such extraordinarily large numbers as a world away from our everyday lives.

Firstly, our pension funds are big owners of this debt, known as bonds. According to Willis Towers Watson, 35 per cent of British pension fund assets are made up of bonds. This is only slightly less than shares. As the interest rate on bonds rise, their value falls. This matters hugely when we eventually come to taking an income from our rainy-day funds.

Secondly, the global bond market largely determines the price we pay on our mortgages, loans and credit cards. An illustration of this was provided last November when the Bank of England raised its headline interest rate but the cost of borrowing largely fell in the couple of months that followed. It is a feature of 21st century capital markets that the price of bonds traded in Tokyo influences the cost of borrowing in Torquay.

Finally, the health of the British government’s finances remains sensitive to what happens in the bond markets. Successive governments have benefitted from falling interest rates. In 1979 when the UK’s national debt was just £450bn in today’s money – less than a quarter of the current level – the cost of servicing this debt, known as gilts, was twice as high as it is today. Both Labour and Conservative-led governments have been able to add to public sector borrowing for decades and paradoxically pay a steadily lower amount in interest payments. Should this trend in interest rates go into reverse, this is money that will need to be found from the budgets for schools and hospitals.

In the early 1990s, an adviser to President Clinton, James Carville, commented: “If I was reincarnated, I would want to come back as the bond market. You can intimidate everybody”. That intimidation is very much in evidence today. What happens next matters to all of us.

A version of this piece was published in The Times.

Simon French

Economics & Strategy