Interest rates have hit bottom, bond markets suggest
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Donald Trump rode to victory in the US presidential election by pledging to "make America great again".
Key points:
- Bond market is double the size of global share markets
- Around a trillion dollars has moved out of bonds since the Trump election
- Rising bond yields are already pushing up some fixed mortgage rates
"We are going to fix our inner-cities and rebuild our highways, bridges, tunnels, airports, schools, hospitals. We are going to rebuild our infrastructure," he said in claiming victory two weeks ago.
While he is still only President in waiting, statements like that have had an immediate effect, with more than a trillion dollars wiped off the value of the global bond market.
"The 30-year rally in bonds is over. That was a golden period. One of the longest rallies we have seen in any asset class," said Justin Braitling, the chief investment officer with Watermark Funds Management.
The prospect of a debt-fuelled, inflation-generating, infrastructure spending spree, along with big cuts to US tax rates, have raised the likelihood that interest rates are on the way up.
"If inflation is going up and interest rates are going up around the world, we will be affected. We're an island, but not financially," explained Hans Kunnen, senior economist with St George Bank.
Bonds are a type of IOU used by governments and companies to borrow money to fund their activities.
The Australian Government currently has $421 billion in bonds, or loans, outstanding - in the United States it is $21 trillion.
"The bond market is absolutely huge, it's about double the size of the global share market," said Elizabeth Moran, who's a director at bond trading house, FIIG Securities.
"It's really worth learning about [the bond market] because, even if you never invest, there's such big movements of money and funds that it's really important to know what's going on."
Bonds are also known as fixed interest or coupon securities because the dollar amount of the interest is fixed when the bond is issued.
For example if a bond is worth $1,000 and the coupon, or interest, is $100, that is 10 per cent.
But if the price of the bond when it is traded on the secondary market goes down to say $500, that $100 coupon payment is now 20 per cent.
Or to put that another way, an organisation wanting to borrow that initial $1,000 would now have to pay $200 in interest.
Bond rates set the price of money
The reason movements in the bond market affect ordinary people living in the suburbs and towns of Australia, and around the world, is that bond interest rates affect the cost of money for all of us.
Banks here borrow in the bond market to fund, among other things, their fixed-rate home loans.
Since the US election, the cost of fixed-rate home loans has started to rise as bond interest rates have gone up.
"Over time that will flow through to your standard variable rate, it will flow through to your car loan, it will flow through to credit cards, potentially," explained Mr Kunnen.
"All interest rates are in one way or another connected."
However, Elizabeth Moran said big increases in interest rates are still a long way off.
She pointed to Westpac issuing more than a billion dollars of bonds in the US since the election, with huge demand from investors, which led to a lower interest rate than Westpac was planning for.
"They can still issue debt into the US at very low rates, they'll continue to do so, so there won't be the same pressure on their balance sheet here to raise rates," she tipped.
Ms Moran added that the economy will also have a big impact on where interest rates are heading.
"Where is the growth going to come in our own economy? Certainly tourism if the dollar stays lower, maybe education, but we don't see any booming growth prospects in Australia," she forecast.
Shares may be out of favour relative to term deposits
But it seems the interest rate cycle is turning and that will have an impact on the share market, where prices have been bid up to unsustainable levels in recent years by investors demanding big dividends to make up for low interest rates.
"It depends on the thinking of each individual investor, what are they after, what's their tolerance for risk. Some people like shares, others don't," said Mr Kunnen.
"But if term deposits are rising there is the potential for less demand for shares."
One group breathing a huge sigh of relief from the election of Donald Trump is retirees.
After nearly a decade of seeing their incomes smashed by low interest rates, they will be hoping that at long last a pay rise is on the way.
Topics: markets, money-and-monetary-policy, us-elections, united-states, australia
