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Home / Business / Companies

Economy Hub: The scary number that's spooking markets

Liam Dann
By Liam Dann
Business Editor at Large·NZ Herald·
1 Mar, 2018 06:49 AM3 mins to read

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US 10-Year Treasuries have become the bellwether for global stock markets. Photo / 123RF

US 10-Year Treasuries have become the bellwether for global stock markets. Photo / 123RF

As big rises and falls on share markets continue in 2018 all the smart money is watching one key graph for direction - the yield on US 10-year Treasury bonds.

And one number in particular is driving sentiment: three per cent.

Anything that causes yields to spike closer to three per cent is causing shares to plunge - as we saw with the correction at the start of the month and again this week.

The yield on the US Treasury 10-year Treasury has become a bellwether for market hopes and fears about inflation and central bank rate hikes.

That means that, for now, the three per figure, controls the destiny of the world's retirement funds - including your KiwiSaver.

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On Wednesday comments by new US Federal Reserve chair Jerome Powell were enough to push the yield above 2.9 per cent - shares on Wall Street fell on cue, breaking a five day winning streak.

So, to help you understand the number that's spooking markets, here's a beginners guide to understanding the bond market:

What are bonds?

Bonds are a fixed interest investment – like a bank deposit except that the investment is recorded as a promise of repayment which can be onsold on a secondary market.

Why are bonds popular?

For Governments and other large institutions they are a secure method of borrowing money directly from the public. Their use dates back to the 1590s.

For investors they are considered a safe bet given the level of risk is tied to the quality and reputation of issuer - often a state government. The US Government has around $30 trillion of bonds on issue.

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Get Sorted: Pitfalls and payoffs of switching KiwiSaver funds

06 Mar 01:06 AM

How are yields set?

Generally, bond yields fall when economic conditions worsen. Economic conditions that might decrease bond yields include high rates of unemployment and slow economic growth or recession.

Right now the US economy is improving and there are signs of some inflation which is causing yields to rise.

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But what about Bond prices?

That is the confusing bit. Bonds are both fixed interest investments and tradeable.

Price and the yield on a bond move in different directions - so if the price falls the yield rises and vice versa - in order to keep the return on the investment in sync with the price.

Why do bonds matter?

Bonds determine what it costs a government to borrow. When a government issues new bonds, and has to pay an interest rate on those bonds that is acceptable to the market.

Why are stock markets spooked?

As bond yields rise they start to look like better value for investors with less risk than equities. Money starts to move from share markets to bonds. Markets fear a tipping point which will see a major sell off from equities.

Why should three per cent be the tipping point?

As Herald markets reporter Jamie Gray told The Economy Hub:

"There's nothing particularly magic about three per cent...markets tend to focus on specific numbers but the trend is the thing," he said. "US Treasury Yields are now at four year highs, that tells you that things are really moving in a profound way."

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