HAMISH MCRAE: Bonds spell fear for grandees of world of finance

Bond yield. For the bigwigs of the world of finance who gather in Marrakesh for the annual meetings of the International Monetary Fund and the World Bank, this is the most important question.

The rise in bond yields over the past few months changes everything: the outlook for the global economy, the chance that some financial institutions will collapse, the national finances of nearly every country, mortgage rates, the lot.

Last week, the yield on 30-year US Treasuries climbed above 5 percent for the first time since 2007, while 10-year yields, just below that level, are also at their highest since before the banking collapse.

High bond yields are among the IMF’s main concerns

So the world’s biggest borrower, the US government, has to pay more to get people to lend it money than at any point in the last 15 years. If rates hit 6 percent, as some in the market expect, it will be the highest rate this century.

This affects everyone because the world is overwhelmed with debt. This will obviously put all borrowers under pressure, as well as the entire global financial system. When this happens, it is difficult to see in advance which parts of this system will break. Warren Buffett, the veteran American investment billionaire, put it succinctly: “It’s only when the tide goes out that you find out who’s been swimming naked.”

So where can the pressure explode? There are some obvious possibilities. One is that the US economy will go into recession. It’s still remarkably strong despite everything that’s been thrown at it, and we’ll see what the IMF economists think.

But I would trust the judgment of Mohamed El-Erian, who was the head of Pimco, the giant US bond management company. He now believes that the combination of this rise in yields and the upward slope in inflation makes a US recession much more likely, and notes that mortgage rates are at a 23-year high.

Government debt problems are another weak link. Our own ten-year-old hogs now yield more than 4.6 percent. That’s well below US rates, but higher than a year ago at the height of the Truss/Kwarteng emergency budget frenzy. You don’t have to be good at math to figure out that most of the cost of servicing the national debt is money that isn’t available for tax cuts.

Some other countries are in worse shape. Italy’s national debt is 145 percent of gross domestic product (ours is just under 100 percent), and the yield on ten-yield bonds topped 5 percent during trading this week. Equivalent French debt is yielding 3.5%, which may not sound bad, but is the highest since 2011.

Most financial institutions are prepared for this. This is what “stress testing” means. But some will not be, and in any case there will be a general dampening effect on the global economy.

As for investors, last year saw many UK pension funds blindsided by the spike in gold yields. So much for the pigs that are officially classified as low risk and the means actually required to keep them.

The same is true of the US national debt. If you had bought 30-year Treasuries last spring, you would have lost half your money. It’s as bad as buying stocks at the height of the dot-com bubble in 2000. In fact, I’ve long believed that stocks, especially in undervalued markets like the UK, are inherently safer than all fixed-income securities. interest including gilts.

However, there is one unpleasant possible outcome for the stock. It is that they will be harmed by the chaos in the fixed rate markets. There are two things here. The first is that if there really is a recession in the US, it will have an impact on the entire world economy. That will reduce corporate earnings, a potential downside that is not currently reflected in U.S. stocks, including the large-cap giants.

So there will be an economic case for lower stock prices, something many US equity strategists predicted earlier this year.

The other is if investors need, for some reason, to raise money and don’t want to crystallize losses from their fixed income portfolios, they will instead sell some of their equity holdings (on which they still have decent profits).

Don’t overdo it, but it’s worth just remembering that October is the classic month for big, sudden sales in stocks.

It’s sunny in Marrakech, with 37C forecast this week, but if you run a national budget or financial services company, you know the winds are likely to be chilly when you get back home.