If markets were parties, the stock market would be the busy host – greeting people at the door, getting people drinks, and making sure the lighting is right.
And the bond market would be the quiet guy in the corner who drew up the invitation list, bought the beverages, paid the electricity bill – and owned the building where the party was happening.
Bonds call the shots. The global bond market is almost triple the size of the global stock market. And about twice the volume of bonds is traded everyday compared to the volume of stocks. And as we’ve written before, the bond market knows more about the direction of the economy than, well, anybody.
1. The interest you pay – and earn
The interest rate you pay on your mortgage or car loan or college loans is directly related to the interest rates for bonds, particularly bonds that mature in five or ten years.
In fact, one of the reasons the U.S. Federal Reserve, the U.S. central bank, started buying trillions of dollars’ worth of bonds (via its quantitative easing programmes) was to reduce lending rates.
Here’s how it works. As the U.S. Fed started buying government bonds, the price of the bonds went up (when there’s more money chasing an asset – whether it’s shares or a Picasso or a condo on Orchard Road – the price increases). When bond prices go up, the yield, or the interest paid, on bonds falls. That’s the way bonds work – when prices rise, yields fall.
As yields decline, it means banks can borrow money (from the central bank) to fund the mortgages they offer at a lower rate. Then they can charge customers a lower rate for the mortgage. (The reverse happens when bond yields go up).
The U.S. Fed started lowering short-term interest rates in 2008 to stimulate the economy. But those short-term rates do not directly affect the interest rates on longer-term bonds, like those that mature in five or ten years.
Longer-term bond rates are set by the market – what bond traders think they should be paying in interest. So, the U.S. Fed also started buying massive amounts of bonds to drive down borrowing rates, and thus make it cheaper for people and businesses to borrow money.
The bond market has the same effect on the interest you earn in a savings account. When bond yields are higher, banks pay you more interest. That’s because of what’s called the yield spread, which is the difference between what they can earn in interest, and the interest they pay you.
When bond yields are low, interest rates that banks can pay depositors are even lower. In some markets, banks even pay the central bank to keep their money.
2. You probably have more debt than before
Because the global bond market has historically low yields, and borrowing costs are low as a result (that is, you can get a loan with a very low interest rate), people and governments have been borrowing more money – a lot more.
According to management consulting firm McKinsey & Co., since 2007 global debt has grown by more than US$57 trillion. This includes a spike in household debt, for things like mortgages and car loans.
Since interest rates started falling after 2008, and bond yields along with them, Asia is now home to the highest level of household debt in the world.
This is often measured by something called the “debt-to-GDP” ratio. This ratio shows the level of debt compared to the size of a country’s economy. The chart below shows how this ratio has grown in almost every major Asian market since 2008.
The interest rate on some debt is fixed. But for other debt, it’s variable. That means that if interest rates rise, the interest rate that borrowers have to pay will also rise. Higher interest rates, leading to higher monthly debt payments, would likely lead to higher debt default levels.
How bad this could get is anyone’s guess. That’s one of the reasons that the U.S. central bank looks less likely to boost interest rates anytime soon.
3. It costs less to fill up your vehicle with petrol
One of the reasons oil prices are so low is because the U.S. is now producing more of its own oil. It is now the world’s largest oil producer. This has increased the supply of oil worldwide, and with all the extra supply prices have fallen.
One of the reasons the U.S. has been producing more oil is because many oil companies have been taking on more debt (that is, issuing bonds) at a low rate to finance their drilling projects. A lot of these projects would not have been economical (that is, they would not have generated a positive return) if interest rates were at more “normal” levels.
As the price of oil has fallen, a lot of these projects are no longer economically viable. But some companies are continuing to pump oil just to generate enough cash to make their debt payments – as they wait (and hope) for higher oil prices.
Of course there’s more to oil prices than just the bond market. But the availability of low-cost borrowing has made the problem worse.
This has affected other commodities as well. One of the reasons there is an oversupply of everything from oil to coffee to iron ore to shipping capacity is that companies have been borrowing money at low rates. This has reduced the cost of many projects, thus making them more profitable… as long as commodities prices are high enough.
So, you can thank the current state of the bond market for saving you a few dollars when filling up your car or motorbike.
It pays to watch what happens in the bond market. Even though most people don’t realise it, what happens there has a major impact on world events, the stock market and our daily lives.