As global bond yields rise to levels not seen in decades, an area of finance that was once unremarkable has now become a focal point on Wall Street. This development has implications for the average Canadian, resulting in increased borrowing costs for items like mortgages and car loans, but also leading to higher returns on investments such as guaranteed investment certificates (GICs) and money market funds.
When an individual purchases a bond, they are essentially loaning money for a specific period to the issuer, which could be a government entity, a private company, or a municipality. Investors typically receive interest payments until the bond reaches maturity, at which point they get back the bond’s face value.
So, what exactly is bond yield? It represents the annual return an investor earns from holding a bond, expressed as a percentage. After bonds are issued, they can be traded on the open market, causing their prices to fluctuate. When bond prices decrease, yields increase because investors receive the same interest payments for a lower purchase price.
Up until recently, the global bond market was relatively quiet due to central banks worldwide maintaining near-zero interest rates for over a decade after the 2008 financial crisis. However, an increasing number of investors now anticipate interest rate hikes as central banks aim to address persistent inflation concerns.
When central banks raise interest rates, newly issued bonds offer higher returns, diminishing the value of existing lower-yielding bonds.
Higher inflation challenges central banks
Currently, the bond market is witnessing a significant global sell-off. Yields have surged to multi-year or multi-decade highs in countries like the United States, Germany, Japan, and Canada.
Bank of Canada Governor Tiff Macklem highlighted the complex factors driving this trend during a discussion following the central bank’s recent interest rate decision. Inflation worries and apprehensions about escalating government debt are contributing to expectations of interest rate hikes by the Bank of Canada and its global counterparts.
According to the latest data from Statistics Canada, rising gas prices played a key role in driving up inflation in July. The Bank of Canada noted that global oil prices remain high, particularly due to ongoing disruptions in seaborne crude traffic in the Middle East amid the U.S.-led conflict with Iran. U.S. benchmark oil prices have surged nearly 60% year-to-date.
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Simultaneously, the Bank of Canada anticipates that the trade disputes between Canada and the U.S. are driving up operational costs for businesses, which could eventually lead to higher consumer prices. Macklem highlighted that the increased demand for new corporate bond issuances due to AI infrastructure development is lowering prices of previously issued bonds.
“All these factors are aligning to elevate global bond yields,” Macklem explained.