With the surge of global bond yields to levels not seen in many years, an area of finance that was once unremarkable has now become a major point of discussion on Wall Street. For the average Canadian, this development translates to increased borrowing costs for certain products like mortgages and auto loans, but it also means higher returns on investments such as guaranteed investment certificates (GICs) and money market funds.
Let’s begin with the basics. When you purchase a bond, you are essentially loaning money to the issuer for a fixed period. This issuer could be the federal government, provinces, municipalities, or a private company. Investors typically receive interest payments until the bond reaches maturity, at which point they receive the bond’s face value back.
So, what exactly is bond yield? It represents the annual profit an investor makes from holding a bond, expressed as a percentage. After bonds are issued, they can be traded on the open market, causing their prices to fluctuate. When bond prices decrease, yields increase, as investors receive the same interest payments for a lower purchase price.
Until recently, the global bond market was relatively quiet due to central banks worldwide maintaining near-zero interest rates for over a decade after the 2008 financial crisis. However, an increasing number of investors now anticipate impending rate hikes as central banks aim to control persistent inflation.
When a central bank raises interest rates, newly issued bonds offer higher returns, making existing lower-yielding bonds less attractive.
Mounting Inflation Pressures Central Banks
Presently, the bond market is witnessing a significant global sell-off. Yields have surged to multi-year or multi-decade highs in countries like the United States, Germany, Japan, and Canada.
“What’s causing this movement? Typically, when there is a significant shift, it is due to multiple factors at play,” stated Bank of Canada Governor Tiff Macklem following the central bank’s latest interest rate decision announcement on Wednesday.
Concerns about inflation and escalating government debt are fueling expectations for the Bank of Canada and its global counterparts to raise their benchmark interest rates.
“Central banks have limited tolerance for higher inflation,” Macklem emphasized. “This has led the market to factor in the likelihood of future interest rate hikes.”
Recent data from Statistics Canada revealed that gas prices were a prominent driver of increased inflation in July. The Bank of Canada highlighted the persistent high global oil prices and ongoing disruptions in seaborne crude traffic due to the U.S.-led conflict with Iran as contributing factors. U.S. benchmark oil prices have soared nearly 60% year-to-date.
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Simultaneously, the bank noted that the Canada-U.S. trade dispute is driving up costs for businesses, potentially leading to higher consumer prices in the future. Macklem pointed out that the expansion of AI infrastructure is increasing demand for new corporate bond issuances, thereby reducing prices for previously issued bonds.
“All these factors are collectively contributing to the rise in global bond yields,” Macklem explained.