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A Clinton-era political adviser once fantasised about being reincarnated as the all-powerful bond market. Thirty years on, the fixed income world has, at times, seemed more intimidating than ever.
The benchmark 10-year Treasury yield climbed to a 16-year high of more than 5 per cent in October, before falling back. The sharp increase from under 1 per cent in 2020 has been a big challenge for many financial sector businesses that hoovered up sovereign and corporate debt in the cheap money era.
Strains became evident in the US banking sector in March. Silicon Valley Bank became the largest bank failure since 2008 after it was caught in a downward spiral caused by deposit flight and losses on bond sales.
Life insurers faced similar issues. Their portfolios of bonds can usually be held to maturity. But there were fears they would become forced sellers, after rising rates prompted some customers — notably in Italy and France — to cash in their policies. However, the pressure eased after June’s announcement of a rescue deal for troubled Italian insurer Eurovita, according to Italy’s Generali.
Corporate debt markets are also vulnerable to rising rates. Moody’s, the rating agency, reported more US corporate defaults in the first half of 2023 than in the entire previous year. With some $250bn of speculative-grade nonfinancial debt maturing in 2024, refinancing could be painful.
Pulling off debt-backed buyouts has become increasingly difficult. The private equity industry has grappled with some of the toughest conditions in its history. That is because rising yields lower asset values while raising the cost of capital. The real estate market has also suffered a double blow. The impact of higher yields has been compounded by declining office occupancy rates.
Slowing inflation has raised hopes that the monetary tightening phase is drawing to a close. In mid-December, Wall Street reacted with euphoria to dovish comments by Fed chair Jay Powell by pushing the yield on 10-year Treasuries below 4 per cent for the first time since August.
However, the battle against inflation is not yet won. Central bankers may yet wrongfoot the markets. Interest rate cuts may be slower than expected. With the indebtedness of governments, businesses and households at a peacetime record, renewed evidence of financial strains may yet emerge.
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