WARNING: There is a fresh financial crisis brewing!
For once it is an increase that is the problem: bond yields.
Why is it potentially bad for investors when the yield of a bond goes up? Because bonds act in reverse, with prices going down as yields go up. Government bonds are experiencing a big sell off right now, pushing prices down, slashing the value of investors’ (governments’) holdings and increasing borrowing costs.
The Background
The crisis has been boiling up for a couple of months. Ben Bernanke of the US Federal Reserve started talking tough on exiting their massive programme of Quantitative Easing, designed to stimulate the economy, two months ago. This position was confirmed in a speech on 20 June 2013 in which he said:
” … we will scale down monthly purchases of Treasury securities and mortgage-backed bonds beginning later in 2013 and ending when unemployment hits 7 per cent, which the Fed expects to happen by middle of 2014; central bank will then take several more years to unwind stimulus campaign”.
This artificial stimulation of the economy is not the sole preserve of the United States, here in the UK we have our own programme of Quantitative Easing and in Europe they have the Long Term Repayment Operation as launched by Mario Draghi of the European Central Bank at the height of the Eurozone crisis.
What does this mean?
A country‘s 10 year bond rate is the level at which it will expect to borrow money in the markets. The change over the last few months has been significant:
In the US these 10 year bonds have gone from a yield of 1.63% in April to 2.58% on the 25th June.
In the UK they have gone from 1.7% at the end of April to 2.53% on the 25th June.
In Germany from 1.25% at the end of April to 1.81% on the 25th June.
In Spain from 4.15% at the end of April to 5.15% on the 25th June.
In Italy from 3.85% at the end of April to 4.85% at the end of June.
These numbers are not only a direct measure of how much it costs our governments to borrow money, but also
- What interest rate we pay on our mortgages and, most importantly,
- the cost of business finance.
The UK economy – planning the Turnaround strategy
Just to put this in context, and let’s just pretend that the UK economy is a large scale Company Turnaround (which of course it is), with George Osborne planning the turnaround strategy and the Business finance strategy.
He has made all his plans and sought to implement them to the best of his ability, in what is a constantly changing, and sluggish world economy. He has a lot of legacy debt to deal with just as you might in any turnaround and he is just about keeping his head above water and paying the interest on the money he has borrowed.
Suddenly BANG, the interest rate he is being forced to pay on the massive debt burden has increased from 1.7% to 2.53% i.e. just under 50%! This would not help any turnaround strategy.
Italy, Spain and Portugal – Turnaround finance?
We all know of the embedded relationships (rightly or wrongly) between the UK and Europe, and the significant role the continent plays in our export strategy. Whilst the region’s woes seem to have stabilised over the past six months, this bond sell-off is causing shock waves, particularly in the Southern Mediterranean countries, and could cause one of the indebted nations to seek a further bail out.
For example, Italy has a debt equivalent to £1.8 TRILLION and their cost of finance has gone up from 3.85% to 4.85%! This equates to an increase in the cost of finance of around 20%. It would make a difference to any turnaround strategy!
Summary
This is an issue that we have to be aware of, particularly in terms of business finance strategy. It is my belief that we have become very comfortable with artificially low interest rates, and have possibly not been preparing our business strategies for the significant hikes in the cost of credit that are just hitting all our governments.
Be prepared – stay flexible – don’t take on too much debt…
Finding alternative funding
If the continuing lack of availability of funding is affecting your business, please contact us. We are specialists in this field and can point you in the right direction.
As always, if you have any comments or any of your own experience you would like to share on this subject, please contact me at john.thompson@transcapital.co.uk or on 0845 689 8750.
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