The world’s most important interest rate rose to the 5 percent mark on Friday. That’s the yield on 10-year US Treasury bonds and the highest since spring 2007. The US government has the highest national debt in the world, totaling $33 trillion (£27 trillion), up $1.6 trillion per year Year.
What has to be paid to service that debt acts as an anchor for all the others. This is not just US businesses and home buyers, but anyone looking to borrow in dollars anywhere in the world.
This also has an indirect impact on the cost of money in other currencies. So here the government is paying 4.7 percent on 10-year Treasury bonds, whereas it paid 3.5 percent earlier this year when the U.S. interest rate was 3.8 percent. In Germany the rate rose from 2.4 to 2.8 percent – and so on.
The gap between what the U.S. government pays and what the rest of us have to put up will vary, but the impact is profound. So if, as some expect, the tax rate in the United States rises to 6 percent, our government will have to pay about 5.5 percent. When it subsides again, the clouds will clear for us too.
It is worth highlighting this point because we are under the illusion that the Bank of England is all-powerful when it comes to setting the cost of borrowing in the UK.
Food for thought: It would be great to know where US bond yields will peak, but no one knows
The serious meetings of the Monetary Policy Committee eight times a year are actually where short-term interest rates are set, and that affects the interest you get on a deposit account or a mortgage tied to the base rate.
But the longer the term of your loan or deposit, the less control the bank has. If you borrow for ten years or more, you have little control over it. Borrow for 30 years and there are none. If you really want to be scared, the 30-year British government bond yield rose to 5.1 percent on Friday, its highest level since 1998.
It would be great to know where US bond yields will peak, but no one knows. Maybe we’re close, maybe not. The increase in recent weeks has shocked the professionals, and almost everyone could not have predicted this increase.
What we know with some confidence is that money is likely to remain expensive for the foreseeable future. We have to get used to it.
So what will this world feel like? Some thoughts.
First, governments will come under increasing pressure to reduce their deficits. You will have no choice but to do this. The whole rhetoric of politicians is about spending money, although they usually use the nice word “invest” instead of “spend” to describe what they do.
Remember how poor Liam Byrne, the outgoing Labor finance minister in 2010, was castigated for making a sincere, if unhelpful, exit from his successor, David Laws? “Dear Prime Minister, I’m afraid there is no money.” Best regards – and good luck! Liam.’
This will impact business around the world. Companies with strong balance sheets will be fine. This also applies to those who engage in activities that involve spending a lot of money. But long-term investments must be worthwhile, and weak companies already struggling under heavy debt burdens will need rescue.
This will move across the entire spectrum, from large to small. I recently spoke to some people who ran retirement homes. They said they could simply add up the numbers at current interest rates, but if they went up another percentage point or more, they would have to stop new projects. There will also be some impact on the availability of venture capital.
This is another point about the appreciation of the solid companies that make up the FTSE 100 index compared to the big technology companies in the USA. I had come to expect this to happen. That hasn’t happened yet, but eventually the value will prevail.
In addition, the general question arises as to how good ideas are financed. The overall venture capital climate has been pretty bleak over the last few months, and the higher cost of money means the difficult times will continue for a while.
As for asset prices in general, markets that have been inflated by cheap money will obviously fall back, but much of that adjustment has already occurred.
The combination of higher wages and slightly falling prices means the UK property market is becoming affordable again, although there is still a long way to go.
British stocks are objectively cheap.
But the biggest change of all will be the mood. All of us – not just governments – will be more cautious, and not prematurely.