New Zealand dollar falls as US bonds hit 'big scary number'

Remember that big scary number behind Wall Street's meltdown in February - the 3 per cent mark on the US 10-Year Treasury bond yield?

Well we've finally hit it.

While it didn't spark the kind of meltdown we saw in February when investors first noticed it was looming, it has rattled markets and had a dramatic impact on the value of the Kiwi dollar.

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

The higher it goes the more convinced markets are that interest rates are going to rise.

A sharp spike in the rate towards 3 per cent caused a Wall Street panic while we enjoyed the sun on Waitangi Day.

On Anzac morning the market closed above 3 per cent for the first time since 2013.

Wall Street fell sharply – although not as far as in February.

New Zealand's stockmarket again missed the brunt of the turmoil due to the public holiday.

But the New Zealand dollar took a big hit. The kiwi today traded as low as US70.59c, its weakest level this year – a long way from US73.94c less than two weeks ago.

While it is good news that equity markets did not lose the plot completely, the trend does point towards more volatility.

The S&P/NZX 50 Index, which has been flat today, is off 3.6 per cent since its most recent peak on March 21.

More broadly the higher bond yield should serve as a warning that after years of central bank policy engineered to help the global economy deal with fallout from the financial crisis interest rates are finally on the rise.

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.

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.

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 it has to pay an interest rate on those bonds that is acceptable to the market.

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

Why was 3 per cent a big deal?
As Herald markets reporter Jamie Gray told The Economy Hub: "There's nothing particularly magic about 3 per cent ... markets tend to focus on specific numbers but the trend is the thing," Gray said. "US Treasury Yields are now at four-year highs, that tells you that things are really moving in a profound way."