How the bond yield 'toxic cocktail' could affect you

Record-high yields have put government bonds back in the news. Experts say the uncertainty is creating issues and opportunities for Aussie investors and borrowers.

What are bonds?

Bonds are essentially loan contracts issued by governments or companies, who use the money they get for them to fund spending.

Because they're issued by national governments and large corporations, they're considered a very safe asset, second only to cash.

When you buy a bond, you're loaning the issuer that amount of money and, in exchange, receiving regular coupon payments.

At the end of the agreed term, you get back the initial face value of the bond.

But you don't have to wait: you can sell bonds before the end of their term on the secondary market.

What are bond yields?

Bond yields reflect the return an investor earns from holding a bond. They're usually expressed as a percentage and are influenced by both the bond's coupon payments and its market price.

Government bond yields are often relatively low, but start to rise when the bonds become less popular and their prices start to fall.

Why are bond yields in the news?

Government bonds are getting attention right now because their yields have been pushing above 5%.

That may not sound like much, but it's the highest they've been in a long time.

Yields on some US government bonds recently hit levels not seen since 2007, while the yield on Australian government 10-year bonds has reached a 15-year high.

Other countries, including the UK and Japan, have also seen their government bond yields reach new heights.

Why are yields so high?

Experts say these increases have been driven by developments in the US and its influential government bonds.

GSFM investment strategist Stephen Miller says the rise in American government bond yields is being fueled by a "toxic cocktail" of high inflation and a large government deficit.

In this environment, the US government is relying on bonds to finance its operations, just as AI companies are looking for money to expand.

"If the US government is issuing bonds to finance a budget deficit, it's competing for investors with AI hyper-scalers, who are also issuing bonds," Miller explains.

This leads to a situation where government bond prices fall and their yields rise as there's more competition for borrowers.

"Governments and AI are both seeking to borrow exceptionally large amounts of money... more people trying to borrow from a smaller pool of global savings is altering the price," says Philip Brown, head of research at FIIG Securities.

Miller says the significant influence of US government bonds in the global economy means a rise in their yields leads to the same elsewhere.

"If US treasuries are selling off, they generally drag other yields with them, so now Australia's got a problem too".

What's the problem for Australia?

Experts say rising government bond yields won't have a direct impact on most Aussies, but effects could filter through in small ways.

"It could affect those who are looking to have fixed-rate mortgages. I think [those] mortgages have gone up because of the lift in bonds," says David Bassanese, chief economist at Betashares.

"The other place it has an effect is the long-run cost of borrowing to the government," adds Philip Brown from FIIG Securities.

"Eventually, governments will need to tighten their belts... how they choose to do that has massive implications for Australians".

Should you invest in bonds?

But these experts also say the falling prices and rising yields on bonds could make now a good time to buy them.

"If you're an income-motivated investor, they might be starting to look attractive," says Stephen Miller from GSFM.

Philip Brown says the falling prices may have hit some superannuation funds holding bonds, but adds the dip has also created opportunities.

"Almost all super funds would have some exposure to fixed-income investments, which would have performed poorly in the last few weeks," he says.

"On the flip side of that, though, if you allocate more to those investments now, you lock in very high yields for a long time".

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