Why the Bond Market Has Everyone On Edge

0:00With HSBC, corporate and institutional banking, finance stays simple as your global footprint grows. Find your next financial partner. Search grp.hspc-uscib I survived nine months in captivity, and I've spent my life exploring how other people survive what should have destroyed them. I'm Elizabeth Smart, and these are the survivor files. Every week, I'm with survivors who live through the unthinkable, abducted, stalked, controlled, and nearly silenced. These are stories about what it takes to make it out alive. Listen to the survivor files with Elizabeth Smart on the iHeartRadio app Apple Podcasts or wherever you get your podcasts. If you're a bookshelf and you're a for-you-page or equally important to your personality, welcome home. Pro Society is a weekly podcast that's part book club, part group chat for anyone who thinks pride and prejudice and love island deserve the same level of discourse.

1:01Each week, we're connecting the dots between books, the internet, and pop culture, with your favorite writers, book talk creators, and plenty of overthought opinions. Yeah, I'm obsessed, I'm obsessed. Listen to Pro Society on the iHeartRadio app Apple Podcasts or wherever you get your podcasts. Bloomberg Audio Studios Podcasts, radio, news Only you could bring in the Bible, Shumpeter. I was gonna bring up the portrait of Dorian Gray. Right. The bond market is has been grabbing headlines and oiling global markets, and everyone seems pretty worried. But the bond market is vast, and it is very complicated, and to talk about the bond market, we need a guide. So to help us us out this moment, we have Friend of the Show, John Authors, opinion columnist at Bloomberg. John, you came on and talked about bonds with us a couple of weeks ago, and we had to pester you again. Because the story won't go away.

2:04No, it won't. It's a fact of life. Bond markets are very powerful in ways that you don't really personally experience. Immediately in your life, but they really are one of the most powerful influences on the world. Yeah, I mean, you've called the 10 year Treasury Note the most important number in the world, I believe. In world finance, in world finance. Yes. This is The Big Take from Bloomberg News. I'm Stacey Manick Smith, Infra David Gura and Sarah Holder. Today on the show, Bloomberg columnist John Authors weighs in on the latest with the bond market. How we ended up on this roller coaster, why markets across the globe are feeling the consequences, and how are we should we be? John, how does the bond market show up in our life? How does it affect us? Well, the key thing for most of us is that it effectively sets the baseline for interest rates on which all other borrowing, frankly, across the world financial system is based.

3:15So the closest approach to a risk-free rate that exists over a long period of time would be a long Treasury bond. The only way you're not going to get paid is if the US goes bust and as the US can print its own supply of dollars to do that, that's very unlikely. And that is essentially a bond is essentially alone. So a 10 year Treasury note is essentially a loan that you would give the government, you'd loan it your money for 10 years. At the end, it would pay you interest on that loan, plus your money back. That's the yield. And lately, the yields have been quite high, relatively speaking. They've been rising and rising, which means the US is paying more interest on its loans, which means borrowing is getting more expensive. Yes. What are some of the main reasons why this is happening? Well, the main reasons we could look at are, first of all, there are other people looking to borrow. When you have competitive people asking for your money, offering you an appealing rate that they're very likely to be able to pay to you, then the need becomes greater to offer a higher rate to your creditors.

4:33And that means that the overall bond rate will go up. So in the case of... So competition, essentially. Yes. So at the moment, there is immense competition for lenders money because of the huge build up for artificial intelligence. Those bonds that are being taken out by the giant companies to build data centers aren't as safe as a 10 year Treasury, but they're about as safe as loans are going to get. And they are offering very attractive yields. Then you have the steady move in inflation. So that's reason number two. We've got competition and reason number two is inflation. Yes. Explain how that gets into the bond market. So if you're lending over 10 years, you are being promised $10 per year or whatever. And the US being the US, you're going to get those $10 a year. And the risk you're taking is that thanks to inflation, those $10 buy you less and less as the years go by.

5:37Oh, yeah. Like by the time you get your money back, you can't buy anything. Precisely. So next, there is the issue of how the central bank will respond. Central banks don't set long term rates. There are some exceptions to that in recent years when central banks have intervened to try to limit long term rates. But you can set what the overnight rate is going to be for banks if you're a central bank. This is the federal funds rate. Yes. So that's what the Federal Reserve controls, but that does trickle down quite fast. Yes. Okay. The more you think that rates might have to rise, the rates charged by the central bank, then the phrase you have to keep using an economics all else equal you would expect. 10 year Treasury yields to rise as well. Oh, because the Federal Reserve might raise interest rates to address the inflation. And then another critical issue in this, because again, this all does relate to the world in which we live is demographics. The more people that are of retirement age who might want to sell their bonds that they've taken out to fund their pensions,

6:48that will tend to mean that there's more selling of bonds going on that will mean all else equal that the, when you're selling the price goes down. So when the population is aging, which it is in the US and in a much more dramatic fashion than quite a number of other places, you would expect all else equal yields to rise. You also had an extremely long period when the baby boom generation was sort of working its way through the population like a pig through a python that's, you know, that this was one of the factors that kept yields falling. It sounds like there are four main reasons that you see. It's kind of like a miasma, I guess. Yes. And then one final point you could add to this, which is the one that garner the greatest attention is ability to pay. In the case of the US, this is a questionable concept because as I said earlier, they do have the power to print their own money.

7:50That said, if you let the deficit run unchecked, it will become more and more necessary to inflate that away to allow inflation to rise, to make it easier to pay that debt. And that will be bad for bondholders requiring you to demand a higher yield in the here and now. So there is an ability to pay element there. That is for other governments and particularly for governments in the emerging world that borrow $1 rather than in their own currency. That is a far more important element of this. I think our debt hit 40 trillion. That's ultimately. It's a lot of money. I think debt is a big issue too. And I think it's interesting to think about because if you're a person and you get into this much debt, you're in a very different situation than if you're a country where you can just print money and pay it off. But when you print all that money, there's so much more money in the system. And then that can create inflation price to start to rise. Yeah. And this is what ultimately is why people like me spend a lot of time talking about inflation and short term interest rates rather than about default risk because that is where fiscal irresponsibility will show up in the US.

9:03And if you're in a developing country that borrows in dollars, it will show up very directly in the risk that you default. After the break, how the bond sausage gets made and what could happen if the global sell off doesn't slow down? HSBC corporate and institutional banking connects capital with opportunity even in the most complex industries set your business up for success. Search grp.hspc forward slash uscib. When I was 14 years old, I was kidnapped and health captive for nine months. I survived and I've spent my life exploring how other people survive what should have destroyed them. I'm Elizabeth smart and these are the survivor files. I just remember this low taunting voice next to my ear saying shut up, don't say anything.

10:03Every week, I'm with survivors who lived through the unthinkable. I knew if he woke up without a doubt he was going to hurt me. I started feeling that there was someone at the end of my bed and I just started screaming. They are abducted, stalked, controlled and nearly silenced. But these aren't stories about what's taken from them. Their story is about what it takes to make it out alive, listen to the survivor files with Elizabeth smart on the iHeartRadio app Apple Podcasts or wherever you get your podcasts. If your bookshelf and your for you page are equally important to your personality, welcome home. This is Pro's Society, the weekly podcast that's part book club, part group chat for thought daughters, pop culture obsessives and anyone who thinks pride and prejudice and love island deserve the same level of discourse. I'm Eli Rallo and every week we're connecting the dots between books, the internet and the conversations everyone can't stop having.

11:04I'm going to have to look up this story. From bestselling authors and your favorite book talk creators to the latest pop culture moments, nothing is off the table. It's like if you can hide some real messages inside compelling characters and that is the Trojan horse, whether you're looking for literary deep dives, smart pop culture conversations or a community of readers who love to think a little too much, you're in the right place. Listen to Pro's Society on the iHeartRadio app Apple Podcasts or wherever you get your podcasts. See you between the pages. One point I'd like to make just because I ran the chart recently and it's fascinating. We are approaching 5%. That's a 5% interest on the loans, 5% yield, which does not sound like much but is like LKAPY10 in fond. Yes, LKAPY10. We topped 5% from about a day three years ago. Other than that we haven't been above 5% for almost 20 years since the very early stages of the global financial crisis.

12:14And then as the financial crisis took off, people got scared about all kinds of other debt piled into treasuries. The treasury yield went down. What I think is important to mention, however, is that so we've had two decades broadly speaking below 5%. The four decades before that, again with only occasional interruptions, we were above 5%. So the entire of the Reagan presidency and almost all of the Clinton presidency were with yields higher than they are now. Both of those presidencies are remembered correctly as having been periods of affluence. You can do perfectly well with a higher cost of money. There were reasons such as inflation was much higher and was only steadily coming under control under Reagan. Clinton brings the deficit under control and eventually gets yields below 5%. But the pain was terrible. There was so much unemployment. John, why is this happening all over the world at the same time?

13:16Part of it is that the US, it is the dog that wagged the tail to in terms of the financial system. Then there is the issue that over a decade after the global financial crisis yields could stay very low for a very long time because the economy was very slow, very sluggish. Yields were held at a level. Everybody gets used to the notion that yields can stay where they are. Everybody gets used to very inexpensive mortgages. Yes. And what you now see following the shock of the pandemic and the inflation wave that followed it is normalization, which can sound polyannarish. I don't mean it to be polyannarish, but this is more of a normalization than a crisis that we are seeing. We have had this very weird period of very low interest rates. There is an old British stand-up comedian joke that people driving these three-wheeled cars called reliant robins.

14:17They were very proud to get a speeding ticket because it proved that they could drive that fast. Fast enough to get a speeding ticket. For two decades, it would be a fine thing if we could actually have inflation of much more than 2% and we would have a problem with growth because that was never going to be the issue. Now we are back to more normal conditions where if you are not careful, inflation will tip above 3% or whatever the issue that you need to worry about again. If we are returning to a new normal, and it's true that even though the rates are relatively high, if you look back over decades, they have been taking out a mortgage loan, bond yields have been in the double digits, we are not near any kind of a long term record. Why is everybody so worried about it? This week we got great jobs and numbers in the US, very surprisingly good. There was a very hawkish speech from Fed Chair Kevin Worsh, so people felt like maybe they knew where he stood a little more and the bond markets really seemed to panic.

15:23Why is there so much worry here? Is it the debt? The single biggest reason, yes, there's just that much more debt outstanding, the impact on the government's borrowing costs and what that might do to the other things it wants to do with its budget becomes that much more significant. And also, plainly, with the growing worries about inequality, when you have an unequal society where more people think they are being treated unfairly, obviously if you raise interest rates, it's the poorest people who are going to get hit worst just as they're worth a bit. But if you're in a risk of risk of getting hit, you can't get a loan. So the risk that if you're already worried that people are very unhappy about where capitalism is at present, higher bond yields give you more reason to worry about what could happen. I'm not predicting revolution here, but I am saying that all else equal. I have more reason to be worried about society, about the future of capitalism, if rates keep rising.

16:29My hair is now gray and all the rest of it. I can actually remember when rates were higher than this, but I was actually fairly young when they were. You can be well into your forties at this point and spent 20 years in finance and not have experience of rates where they are now. And basically by the time you're into your mid-forties, the people who are right at the top of the tree are about that age, particularly if you're bond trading or whatever. That's not an old person's job. In terms of at a psychological level, this is something which people haven't experienced before. So do we not have anything to worry about? Is the bond market panicking unnecessarily? Can we all just relax and go about our lives and just know that this is a pretty normal interest rate? We just have a distorted view and all will be well. Okay, I would kind of agree with that, but I would change the emphasis a little. I'm not sure that bond market is panicking. I think the bond market is still fundamentally rationally raising higher because it's recognizing that the tectonic plates we've been discussing, demographics inflation, quantum of debt,

17:40have moved in such a way that rates need to be higher. It's reasonable to expect that for the next few years yields will steadily rise. That will crimp the returns in the stock market that will crimp what governments can do. It's not necessarily unhealthy. If you want to put the Adam Smith Milton Friedman perspective on this, or Shumpiton, particularly the notion of creative destruction, that's a good thing. Yeah. Capitalism is about the balance of greed and fear. If you take away the fear through really not charging for money for a long period after the crisis, but leave the greed, you have an uncomfortable mixture. If you bring back the fear, if you actually get some of the companies that are hogging capital, that are not making good profits with it, that are not really able to employ people on a good wage with it, if rates move to a level where they actually ration capital, and you do get creative destruction with it where you get some more of the survival of the fittest.

18:52Separate the weed from the chat. It's ultimately a cruel but more truly capitalist world, which might ultimately give you a stronger economy, and once you've gone through the pain, might be a stronger economy for everyone. John Others, thank you so much. With something like the bond market, you have to call on all the forces, literary and historical. This is why you're our man on bonds, John. Thank you. This is The Big Take from Bloomberg News. I'm Stacey Manick-Smith, Infra Sarah Holder, and David Gura. To get more from The Big Take and unlimited access to allofbloomberg.com, subscribe today at bloomberg.com slash podcast offer. If you liked this episode, make sure to follow and review The Big Take, wherever you listen to podcasts, helps people find the show. And thank you for listening. We'll see you tomorrow.

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