Here's a quick note on Bonds and Interest rate situation in US & EU.
Central banks have increased interest rates at accelerated rate. Yesterday, US increased the FF rate by 75 bps. Europe is speeding up tapering of its bond purchases and has vowed to raise the interest rates. Higher interest rates would increase the burden of debt service costs for the central banks and economies.
In Europe, mere plan of ending the QE program have blown out the bond markets, with shooting bond yields of member nations including high indebted economies like Spain and Italy having debt burden of 118% and 150% of GDP respectively. These fears have got re-awakened after European Debt Crisis of 2010s. Naturally, it is clear what interest rate hikes would do.
Bond Yields are a function of interest rates, default risk or credit risk of an economy. As the risk increases, the yields rise and bond prices fall, leading to capital losses. (Yields also are impacted by inflation, liquidity premium, credit worthiness).
US bond yields are also rising. Yields rose to 3.39% today from 1.3% a year back. US Fed in its tough talks are addressing their aggressive view over future interest rates hike, to beat (missed) burgeoning inflation. US debt levels currently are as high as 137% of the GDP.
Thus, any rise in rates will create great difficulty in servicing the debt. So, do we really think that central banks will resort for the rate hikes? Upside to interest rates hikes by central banks is limited. Alternatively, they are trying to bring down the sentiments and cut down on demand by targeting job markets, while many of the inflation causes are lying on the supply side.
Once recession sets in, it will be peak for interest rates hike. It is quite possible that QE programs may resurrect as economies get pushed into a deeper recession.
- Ushma Zunzavadiya
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