The Bull

Wednesday 17

January, 2018 6:39 AM


  • Your
  • Portfolio

If the 'bond market rout' continues it could impact home prices

If the 'bond market rout' continues it could impact home prices

By Expert Panel 21.11.2016

For the past three decades the yields on long-term bonds have been on a downward trend. This has dramatically reversed since the election of Donald Trump, with more than a trillion dollars wiped off the global bond market in the past week and a half.

But it’s not just investors that are impacted by this spectacular reversal. The bond market is a backbone of the global financial system, meaning the sell off has implications far and wide, from economic growth through to real estate prices.

What’s happening in bond markets

Bonds are a type of long-term debt - companies and governments sell bonds to investors and these will in turn be bought and sold on the bond markets.

The thing to look at with bonds is the market price, which is reflected in the yield quoted or price paid when a bond is bought and sold. Investors in bonds receive their returns in regular interest payments and the return of principal when the bond matures.

As the price of the bond rises, the yield will drop. With the price of bonds steadily rising during the 30 year bull market, yields have fallen away significantly, bringing down the interest rates around the world.

US 10 Yr Treasury Yield.

Why we pay attention to the bond market

The price of bonds filters through into the rest of the economy. This is because government bonds are considered relatively risk free, and so act as a benchmark for pricing (relatively more risky) securities in all other markets.

A company’s shares, for example, are expected to yield the risk-free rate (what a government bond would yield) plus an additional amount to compensate investors for their riskiness - called the “equity risk premium”. Investment in corporate bonds can be expected to yield the risk-free rate plus a premium for taking on the added default risk.

The US bond market is especially important, as it is the largest and its prices act as a benchmark for interest rates globally. Rising bond yields in the US signal a number of things - higher expected inflation from the touted tax cuts and higher spending, and the need to borrow to fund this expansion. All of this puts further downward pressure on bond prices and upward pressure on interest rates, increasing yields.

Overall, bond prices serve as a “barometer” of what the market is “thinking”. Especially what it thinks will happen in the future, as the relation between long term interest rates and short term interest rates has a mechanical effect on future interest rates.

What this could mean

The sudden increase in bond yields, most notably the 10 Year US Government bond yields, has broad implications for the economy.

Mortgage rates are tied to the 10 year bond yield, for example, meaning borrowers will need to pay more for housing loans. This won’t happen overnight and we will have to wait to see the long-term effect on real estate prices.

But taking in past history, here are a range of possibilities from the end of the bull market.

First, when long-term interest rates are higher than short-term interest rates, the market expects interest rates in the future to be higher. This suggests that this market sell off isn’t an aberration, we can expect higher yields and lower bond prices in the future, and this trend will continue.

Second, long-term bond yields generally reflect an economy’s long-term real growth rate plus a premium for inflation. Inflation measures around the globe have been quite low and central banks have struggled to reach their inflation targets. Rising bond yields could mean the growth starts to tick up.

Third, there will be more uncertainty in global markets until the implications of a Trump presidency are known. Investors will expect a greater return to investment in US government bonds because of this heightened uncertainty. So yields on long-term US Treasuries are likely to stay up and even increase further in the foreseeable future. But even so interest rates are still low by historical standards.

Fourth, new borrowing for housing will be more costly. The risk of rising interest rates on existing mortgages has been mostly shifted elsewhere in the US economy. Let’s hope that the institutions or individuals holding that risk fare better than the institutions which collapsed during the savings and loans crisis in the US in the late 1980s.

Fifth, this is a permanent change in the nature of global interest rates. Rising bond yields could push up interest rates. Australia’s Reserve Bank Governor Phillip Lowe has signalled no further interest rate cuts unless inflation drops well below its current 1.5% level.

The Conversation

Christine Brown, Professor and Head of the Department of Banking and Finance, Monash University, originally published on The Conversation.

>> BACK TO THE NEWSLETTER: Click here to read other articles from this week's newsletter


Are we in for a rough year in 2018?

If 2018 pans out like some of the early... More

Top 30 shorted stocks

Each week we feature the top 10 shorted stocks... More

Investor Signposts: Week Beginning January 15 2018

A raft of key economic indicators are due for... More

What we can expect from China's economy in 2018

In 2017, we saw the consolidation of China's... More


week 19 January 2018
    • 15
    • CoreLogic Capital city house prices for the week just ended | 8:30 AM
    • 16
    • ANZ Roy Morgan Consumer Confidence weekly survey | 8:30 AM
    • 17
    • ABS Housing finance for November | 8:30 AM
    • 18
    • BHP Half year operational review | 8:30 AM
    • 19
    • ABS Lending finance for November | 8:30 AM

TheBull PREMIUM article search

Index: Points Change Percent

Featured Comment

That could be an opportunity for patient value investors to buy at lower prices and gain exposure to one of the few small Australian retailers with an expanding global footprint and less exposure to the online threat.

Retailers that can survive online barrage

Broker buys

  • ASX Code
  • Company
  • Broker
  • FMGFortescueSanlam Private Wealth
  • WSAWestern AreasSanlam Private Wealth
  • GRRGrange ResourcesFairmont Equities
  • ORGOrigin EnergyFairmont Equities
  • NANNanosonicsShaw and Partners
  • GMAGenworthShaw and Partners

Broker sells

  • ASX Code
  • Company
  • Broker
  • CGCCosta GroupSanlam Private Wealth
  • A2MA2 MilkSanlam Private Wealth
  • VRTVirtus HealthFairmont Equities
  • SHLSonic HealthcareFairmont Equities
  • SEKSeekShaw and Partners
  • NHFNib HoldingsShaw and Partners

Central Banks Rates

  • RBA1.50%
  • FED0.50%
  • BOE0.25%
  • BOC0.50%
  • RBNZ2.00%
  • ECB0.00%
  • SNB-0.75%
  • BOJ-0.10%

Upcoming dividends

  • ASX Code
  • Company, Div., Franking
  • Ex-Div.

Eight brokers like these stocks

  • ASX Code
  • Company Name
  • Consensus Target

Upcoming Floats

  • ASX Code
  • Company Name
  • Float Date


© Copyright The Compare Group Pty Ltd. All rights reserved.