Recession on the Way
Recently the government Bonds have found there way to the main headlines John Stepek says in his 25th June’s article “Why a recession is on the cards” for MSN Money. Although things have stabilised somewhat now, the yield on a 10-year gilt (UK government bond) last week hit a seven-year high of nearly 5.5%, while in the US, the yield on a 10-year Treasury (US government bond) also shot up.
Roger Bootle of Capital Economics said in The Telegraph, “It may seem esoteric to you, but the yield on government bonds is the foundation on which all asset values rest.” Hence, if you can get a yield of say 5.5% by lending your money to the UK or US governments (which are regarded as virtually risk-free), then anything riskier (which is just about anything) needs to offer a better return than that. Thus for yields to rise, prices have to fall.
One of the main reason for all of this is that the traders are finally getting wise to the fact that interest rates across the world are heading higher, and still aren’t at a peak which means that the markets are no longer counting on the US Federal Reserve to cut interest rates any time soon. The central bank has trouble cutting rates due to inflation. With oil prices, food prices and other general commodity prices still soaring ahead, inflationary pressures are picking up across the world. A very visible example was when the Bank of England recently had to write to Chancellor Gordon Brown after consumer price inflation rose above 3% earlier this year.
Another factor affecting this whole situation is the consumer spending power. As rates rise, the amount of money consumers have in their pockets is squeezed by higher mortgage bills, while it becomes more expensive to borrow money on credit cards and the like. As consumers start to worry that they can no longer rely on soaring home prices to fund their retirement, and realise that they may have to actually start saving some of their income. The consumer spending power will be further affected.