It's over. Governments and big corporations no longer have borrowed money on tap at the lowest interest rates on record.
In a historic shift, one already under way but amplified by the shock election of Donald Trump, investors have dumped the ultimate risk-free asset in finance, an IOU from the US government.
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The yield on US Treasury bonds this week surged, with 30-year bond yields hitting a 2016 high above 3 per cent, after bottoming in July. The change means investors are demanding more to lend their money to governments and corporate giants alike.
Bond yields, which move inversely to prices, have jumped by more in the past, but many experts say this looks like a key turning point. They believe the era of ultra-cheap credit is coming to an end.
Corporates count cost
It is a change that has sweeping economic implications, as highlighted this week by the general manager of the influential Bank for International Settlements, Jaime Caruana.
"Corporate treasurers use these yields to assess the value to shareholders of real investment projects," he said this week.
"These yields determine how much households pay on their fixed-rate mortgages. And they have become the cornerstone of valuation of other long-term assets, ranging from equities and real estate, to gold and foreign exchange," he said.
But what does the great bond sell-off mean for Australian business?
Large corporate borrowers outside banking and the cyclical mining sector raise about $100 billion a year in debt, according to the Reserve Bank.
Most of this still comes from banks, but there has been a shift towards greater use of the bond markets by corporate giants since the global financial crisis.
Bonds double
There has been a near doubling in the value of long-term corporate bonds on issue in overseas markets since 2008, with Australian non-financial corporations borrowing some $172 billion on world markets, RBA figures show. Domestically, non-financial bonds on issue have also grown by about a quarter to $51 billion since the GFC.
These businesses will inevitably feel some impact from rising credit costs.
Debt is probably still going to stay cheap, but I think the best is probably behind us.
CBA chief credit strategist Scott Rundell
CBA chief credit strategist Scott Rundell said the average yield on Australian corporate bonds had lifted from about 3.2 to 3.4 per cent since the US election.
"In a week, it's a massive move," he said.
"Debt has been as cheap as it's ever been. Companies, on average, have never theoretically been able to issue bonds at 3 per cent," Rundell said.
At the low point in August, the average large investment-grade Australian company would have been charged $2.8 million in interest every year if they were were raising $100 million worth of five-year money from the bond market. Now, the annual interest bill for a company raising five-year debt has lifted to about $3.5 million.
Still cheap
Even so, it is still very cheap debt by historical standards. Indeed, new bonds issued today are likely to be replacing more expensive debt.
Rundell says about $8 billion in Australian dollar non-bank corporate debt is due to mature next year, but at current prices, companies could still roll over this debt at prices lower than they were paying right now on bonds issued in previous years.
"What it might do is change where companies get their debt," he said.
"Debt is probably still going to stay cheap, but I think the best is probably behind us."
While higher credit costs may sound like a bad thing, it could also be a sign of brighter economic prospects ahead.
Most argue the latest jump in yields is occurring because investors are betting Trump's plan for an infrastructure spending spree and tax cuts will unleash inflation. Higher inflation erodes the value of a bond promising to pay 2.5 per cent interest every year.
Inflation works
For companies, however, a bit more inflation could be a good thing. If it is accompanied by stronger economic growth, as investors are betting, it could make wary corporate boards more likely to commit to large capital investments or acquisitions.
AMP Capital's chief economist Shane Oliver says this expectation of slightly higher inflation could also help companies raise prices more easily, offsetting some of the crunch on their profit margins.
He points out yields were rising in the early 2000s – but this did not create problems for business because it came amid a stronger economic backdrop.
Banks are by far the biggest issuers of non-government bonds, raising about $100 billion a year in domestic and overseas markets, and they will also pass on any increases in their costs to customers with products linked to bond rates. Some lenders have already raised fixed-rate mortgage rates recently, for example, and others are tipped to follow.
REIT rout
Outside the financial sector, those most likely to be affected by rising bond yields include the highly geared infrastructure businesses, utilities and real estate investment trusts (REITs).
Sometimes known as "bond proxies" because of their reliable dividends, many of these sectors have slumped heavily as bond yields have spiked. An index of REITs on the ASX200 has dropped 18 per cent since early August, about the time yields bottomed.
Watermark Funds Management analyst Omkar Joshi said bond-like shares in infrastructure, real estate, telcos and utilities tended to perform poorly as bond yields rose. That is because investors who had bought these stocks as a substitute for bonds may put their cash back into fixed-interest assets.
Other sectors such as industrials tend to be less leveraged, after many have taken the recent years of cheap debt to get their balance sheets in better shape.
Even so, ANZ interest rates strategist Martin Whetton says companies with debt will have to think about strategies for managing the funding risk, and ultimately, any impact on their margins.
"Most around the world have not be prepared for this," he says.
"It's significant enough that it's now a factor in their thinking. It would not have been a few months ago."
Banks sought
There is a possibility that higher bond yields drive corporate borrowers back towards the banks, reversing the trend towards greater use of bond markets since the global financial crisis.
Yet a senior banker in the debt markets estimates an increase of this size is not enough to seriously crimp profit margins, and could actually be a positive sign, because rising yields may signal an economic bounce on the horizon. He argues corporate borrowers would have few problems even if 10-year yields blew out to about 4 per cent.
If bond yields rise more dramatically, however, this could present a bigger headache for companies, and investors.
In what is known as the bond massacre of 1994, yields on 30-year Treasury bonds surged by some 200 basis points in months. This triggered a surge in yields globally, which blew out borrowing costs. A shock of this scale today could surely upset the world economy.
There are reasons to believe that may not occur this time, however, because investors would probably have to expect a sustained major jump in inflation to push yields sharply higher.
When wage growth is stagnant in most wealthy countries – including Australia where pay packets are growing at record low pace – such an inflation outbreak looks unlikely.
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