The prices of some of the most significant assets in financial markets – US Treasury bonds, crude oil, and the US Dollar – have been on the move. In general, these moves have been unhelpful to investors. The most important of the changes has been in US Treasury bonds, where “the sell-off in global markets has gathered pace and yields on 30-year Treasuries hit 5%, the highest level since 2007” (Bloomberg News, Oct 4th).

With around $24 trillion outstanding, US Treasury bonds are, arguably, the world’s most significant financial assets. Their rising yields equate to losses for bond holders. For the US government, it means higher borrowing costs when it issues new bonds. Furthermore, government borrowing costs influence everything from mortgage rates for homeowners to loan rates for companies. They also affect share prices, as potential returns from shares need to be competitive against those available from bonds. Indeed, shares outside the USA are now down for the year. And in the United States, even shares in the ‘Magnificent Seven’ technology firms – the high-flyers of the past few quarters – have been stopped in their tracks.

But why has the cost of US government borrowing risen so sharply? Dozens of articles have now been written on this topic, trying to make sense of the moves, but there’s been no agreement on the underlying cause.

We do know one important thing, though: it was not because of higher inflation expectations. This matters because changing inflation expectations have been the main driver of asset prices since 2021, when the Federal Reserve admitted that price inflation was no longer “transitory”. Asset prices slumped in late 2021 when central banks tried to tackle inflation by raising policy interest rates; and then regained some poise in late 2022 as hopes emerged that inflation had been vanquished. But last quarter, bonds slumped even though inflation expectations hardly budged. Thus, there must be a new driver of asset prices. But what exactly is that new driver?

One possibility could be called ‘normalisation’. Treasury bond yields rose because hopes for an imminent cut in policy interest rates have been dashed. Instead, rates will “stay higher for longer” and the prospect of a return to near-zero interest rates has almost vanished. Recall that US and UK policy interest rates were cut to near-zero as an emergency response to the Global Financial Crisis of 2008…and they even went below zero in Japan and the Eurozone! Rates stayed low for around thirteen years, and we rather got used to them being there. Arguably, markets are now normalising after this long aberration.

Another suggestion is that the market is demanding higher returns to compensate for risks associated with a profligate and increasingly dysfunctional US government. On most measures, the US government does indeed look profligate – budget deficits are comparable to those usually seen in wartimes, and many fear how bad the deficit (and thus bond issuance) could get if a recession should arrive.

A third theory is that it could be simply the effect of Chinese government selling. There is some evidence that Chinese agencies – amongst the biggest owners of US Treasuries – have been net sellers over the past year or so.

Whatever the reason, the rise in US bond yields – combined with higher oil prices and a stronger US Dollar – amounts to an effective ‘tightening’ of financial conditions for most of the world; a headwind for investors.

China woes
Another important matter for investors’ concerns developments in the People’s Republic of China: its economy, markets, and relationship with the USA amongst others.

It’s well known that, over the last the last thirty or so years, China has experienced rapid industrialisation, urbanisation, and economic growth; combined with impressive technological development (think Comac jets, BYD electric vehicles or SMIC microchips). Less well known is that its stock market has been largely disappointing: It has meandered for roughly the past 15 years. Although this might seem surprising, it’s not uncommon for economies and stock markets to move independently of one another. Most studies of financial history show little, if any, long-term relationship between economic growth and excess stock market returns.

Although Chinese shares have languished, the property market has boomed, both in terms of prices and new construction. Yes, it’s not just Britain where conversations can quickly turn to house price trends and property portfolios! Recently, though, several large property developers have entered financial distress, struggling under huge borrowings and dubious investments. The Financial Times reports that property giant Evergrande had been forced to sell off the company jet and yacht(!), amongst other assets, in an attempt to reduce its debt pile. The housing boom has turned to bust, and prices are falling.