Spiralling government interest costs have brought new risks for investors. This week, the head of the International Monetary Fund (IMF) warned that the world’s advanced economies need to cut borrowing and reduce debt levels. Across the US, UK, eurozone and Japan, the interest rates that governments must pay to borrow money over the long term have climbed to levels not seen in decades. For savers and investors, this matters more than it might first seem, since it touches mortgage rates, pension values, and the price of shares held in portfolios.
The US 10-year Treasury yield – the benchmark that sets the tone for global borrowing costs – has been sitting close to 5%, with the 30-year yield at its highest point in almost 20 years. UK 30-year government bonds (gilts) have gone further still, touching levels last seen in 1998, and the 10-year gilt is back where it stood during the 2008 financial crash. German government bond yields have climbed too. In Japan, the 10-year yield is at its highest since the mid-1990s and the 30-year is at a record high.
Read more:
Several forces are combining to push up yields. The conflict involving Iran has moved oil prices back above $100 a barrel and triggered renewed inflation. Conflict increases costs across the supply chains of food, energy and other materials – encouraging sourcing nearer to home and an overall trend of de-globalisation.
A higher rate of inflation is now embedded globally; unfortunately, there is little that any single government can do about this. The UK is just one of many governments that have responded to the higher cost of living and lower growth by spending and borrowing more.
UK national debt sits close to 95% of gross domestic product (GDP), a level not seen since the early 1960s, and debt interest last month was the highest August figure since monthly records began in 1997. The Chancellor faces a Budget at the end of October with far less room than hoped, and higher taxes, tighter spending, or both, look likely. The UK financing deficit may even pose a risk to the value of the pound – cautious British investors might aim for greater overseas investment in their portfolios.
Additional pressure on debt markets comes from an unexpected quarter; the technology giants building AI data centres. Firms such as Microsoft and Alphabet, once famous for barely needing to borrow at all, have turned into some of the biggest bond sellers in the world, raising hundreds of billions of dollars to fund computer chips and power supplies. This wave of borrowing competes in the bond market with governments already selling huge amounts of debt.
Japan may be the country to watch most closely. Its government debt is well above 240% of GDP, by far the highest of any major economy, and for decades this was hidden by the Bank of Japan buying huge amounts of its own bonds and holding yields near zero. That policy is now being unwound and yields are rising fast. A real wobble in Japan would ripple through world markets quickly, given how much Japanese money is invested abroad.
For equity investors, higher long-term interest rates change the arithmetic. Shares – especially those priced for years of fast growth – become less attractive when a safe government bond pays 5% or more, since future profits are worth less in today’s money. Firms that rely heavily on borrowed money deserve closer scrutiny than before.
A well-spread portfolio, across regions and types of asset, remains the best defence against any one country’s troubles.
Colin McLean is a director of Barnton Capital