Thirty-year gilt yields topped 6.0% for the first time since 1998 before cooling to 5.97% by the end of trading on Thursday (October 1), according to analysis. The yield, effectively the interest rate on government debt, was pushed higher by Andy Burnham's fiscal plans, heightened tensions in the Middle East and fears over inflation.
Bond market reaction
Movements in the bond market saw the FTSE 100, FTSE 250 and AIM all-share slide, while the CAC 40 in Paris and DAX 40 in Frankfurt all closed down yesterday.
Dan Coatsworth, head of markets at broker AJ Bell, said a 30-year gilt yield above 6% is a "clear sign" bond investors want greater compensation for lending money to the British Government. He added: "On one level, gilt yields breaking through the 6% barrier implies bond markets are unhappy at Prime Minister Andy Burnham’s plans, and they want a higher reward for the risk of lending money to the government for long periods."
Inflation and global pressures
The expert noted, however, that there is "more at play", adding: "Inflation fears are the predominant driver for the bond sell-off, and that’s why US government bonds are also experiencing a rout."
On Thursday, the yield on the US 10-year Treasury was at 5.30%, up from 5.28% on Wednesday. The yield on the US 30-year Treasury was at 5.63%, up from 5.62%. Some relief returned to the rattled US bond market on Friday (October 2) after the latest jobs report damped down fears a hot US economy could worsen inflation.
Mr Coatsworth said the biggest concern is that higher oil prices will reignite inflation just as central banks appeared to be taming price pressures. He added: "If inflation remains elevated, central banks may need to keep interest rates higher for longer, pushing up borrowing costs for households, businesses and governments alike."
Government finances under scrutiny
AJ Bell's expert said investors are also asking questions about the sustainability of government finances. He said bond investors will waste no time in letting the world know when they lose faith in a government's tax and spending plans.
Mr Coatsworth said when investors lose confidence in government finances, they can effectively sell bonds in protest. This pushes bond prices down and yields up, with higher borrowing costs potentially acting as a powerful incentive for governments to restore market confidence.
Russ Mould, AJ Bell's investment director, summed up his reading of the situation: "Heightened tensions in the Middle East, concerns over the UK’s fiscal situation, and sticky inflation are all feeding into government bond yields."
Impact on shares, cash and mortgages
Mr Coatsworth said when gilt yields rise it makes bonds a more attractive option to shares. Traditionally, bonds are typically viewed as less volatile than shares.
"When investors can earn a relatively high return from government debt with limited risk, equities must work harder to justify their additional volatility," Mr Coatsworth said.
Rising bond yields usually mean better returns on cash, but according to AJ Bell's expert this also "raises the hurdle" for other investments as investors can earn a "decent" income without much risk.
On mortgages, Mr Coatsworth said rates on these products are heavily influenced by government bond yields and swap rates. Swap rates are the rate of interest lenders pay to financial institutions in return for fixed funding.
Mr Coatsworth explained: "When gilt yields rise, lenders’ funding costs tend to increase, which often feeds through into higher mortgage rates. That can mean higher repayments for homeowners and a cooler housing market as some people find they fail mortgage affordability tests, which removes would-be buyers from the equation."
