3 min read 2 Aug 21
You might have seen headlines about rising US government bond yields and wondered if this has any effect on you. The effective rate of interest that the US government pays to borrow money can indeed have a bearing on all of our financial futures.
With the US economy growing rapidly, 10-year US government bond yields have risen. After hitting record lows last year, they have stayed above 1% since January 2021.
Though they remain historically low, a rapid rise in the yields of US government bonds (known as Treasuries) can ripple out through other assets, affecting everything from technology stocks to the housing market.
Remember, past performance is not a guide to future performance.
Rising confidence in the prospects of the US economy has contributed to rising bond yields.
The strong economic recovery from the pandemic, supported by very low interest rates and extra spending by the US government, has fed inflation fears in the bond market. Indeed, the US consumer prices index of inflation hit 5% in May 2021 – its highest annual rate since 2008.
Inflation is rising because the US market is heating up. Consumers are spending again, pushing up demand, but there are also supply chain issues from businesses not being able to operate as normal yet. This imbalance between demand and supply results in prices going up.
Inflation matters for bond prices because it can erode the real value of the fixed interest coupon you earn on a bond, as well as the capital you can expect to receive when it matures. Due to the inverse relationship between bond prices and yields, falling bond prices result in rising yields.
US Treasury yields influence global asset prices. As the world’s largest economy, the returns available on US government debt are a global benchmark. Other bonds are priced by comparison, meaning that government and corporate bonds elsewhere across the globe will typically be expected to follow suit.
Stockmarkets have rallied since the market downturn of March 2020, as the world began to emerge from the first lockdown with vast government support for economies. Those companies that have been able to benefit and take advantage of the new environment, such as technology companies, have made particular share price gains.
With the development of COVID-19 vaccines and a new US President in Joe Biden, confidence in the outlook for the US economy has risen. The unveiling of plans for US$1.9 trillion in fiscal stimulus by the new president further buoyed investors, and so share prices.
Meanwhile, in March 2021, the Federal Reserve (the US central bank) cut interest rates to near-zero levels in order to spur further borrowing and investment, to help propel the economy out of the pandemic.
This has all contributed to higher yields on US Treasuries. The US 10-year Treasury bond yield was 1.5% in June 2021, after hitting a low of 0.5% in March 2020.
US Treasury yields are something we, in the M&G Multi Asset team, are watching closely as they play such an important role as a reference point for global investors.
In recent years, government bonds have been able to effectively diversify a portfolio at times when riskier assets (like company shares) have been hit by investors worrying about economic growth. Rising interest rates have the potential to cause weakness in all assets, however, making this kind of diversification harder to achieve.
That said, now is not a time for long-term investors to panic. It is not a given that inflation is on a higher long-term trajectory. There are strong reasons to suggest that much of its recent rise is due to one-off factors, given the severity of the downturn in early 2020. If much of the recent rise in inflation proves temporary, central banks may not feel the need to raise interest rates in response.
The direction of US Treasury bond yields, and therefore those of other bonds around the world, is therefore far from clear. As ever though, by diversifying your holdings, you give yourself the best chance to meet your long-term investment goals.
Please bear in mind that M&G is unable to give financial advice. The views expressed here should not be taken as a recommendation, advice or forecast.
The value of any fund's assets will go down as well as up. This will cause the value of your investment to fall as well as rise and you may get back less than you originally invested.