Long-term Government Bonds yields in the United States, Europe and Japan are rising to the highest levels in decades. As concerns about fiscal deficits grow, more investors are selling the Government Bonds they hold. As a result, Government Bonds prices are falling to the lowest levels. Some are even forecasting that Government Bonds may lose their status as a safe asset and, like stocks, become a risk asset.
◇ U.S., Japan and Germany 10-year Government Bonds yields hit the highest in decades
According to the bond market on the 18th, the yield on the U.S. Government Bonds (10-year), the benchmark Government Bonds, stood at 4.73% that day. After climbing to a record high for the year of 4.74% at the end of July and then dropping more than 1 percentage point within a week, it is widening its gains again. The yield fell from 4.24% at the end of January to 3.96% at the end of February. But it rose to 4.32% at the end of March as the Middle East war intensified, 4.37% at the end of April, 4.44% at the end of May and 4.47% at the end of June.
This trend is also appearing in Japan and Europe. The yield on Japan's Government Bonds (10-year) rose to 2.94% that day, the highest level in 30 years. The yield fell from 2.24% at the end of January to 2.12% at the end of February, then reversed higher to 2.35% at the end of March. It climbed each month to 2.53% at the end of April, 2.67% at the end of May and 2.68% at the end of June.
The yield on Germany's Government Bonds (10-year), the eurozone benchmark, was 3.21% that day, the highest since 2011. The yield fell from 2.84% at the end of January to 2.64% at the end of February. It broke above 3% in March and rose to 3.11% at the end of April. It fell to 2.94% and 2.86% at the end of May and June, respectively, then jumped in July to 3.21%.
◇ Government Bonds moving in the same direction as stocks… "Weaker hedging function"
Experts see fiscal deficits as a key driver of rising yields. The U.S. federal government's July fiscal deficit was $432 billion, already exceeding last year's full-year shortfall. Japan's national liability stood at 1,346.68 trillion yen as of the end of June, an all-time high.
To cover a deficit, the government must issue additional Government Bonds. To sell the issued Government Bonds, it has to offer a higher yield than existing levels. There are also concerns that the interest the government must bear will increase, leading it to rely again on Government Bonds issuance. As the supply of Government Bonds increases, prices fall, which can reduce the investment incentive.
Kim Yoon-kyung, head of bond analysis at the International Finance Center, said, "The deterioration in government finances has been a factor putting upward pressure on Government Bonds yields since last year," and noted, "As high rates increase the interest burden, finances worsen, and that appears to have fueled doubts about instability leading back to Government Bonds issuance."
The decline in the "hedge (risk aversion)" effect, in which Government Bonds partially offset losses when stock prices plunge, is also eroding the appeal of Government Bonds. When prices of risky assets like stocks fall, Government Bonds prices typically rise. But recently, Government Bonds and stock prices have moved in the same direction, reducing the benefits of diversification.
BlackRock, the world's largest asset manager, said in a report released on the 3rd that the correlation between returns on U.S. stocks and Government Bonds over the past five years was positive (0.07). A positive correlation means the prices of the two assets moved in the same direction. BlackRock said, "Bonds have seen their effectiveness as a portfolio buffer drop significantly."