Bonds, rising yields and global sell offs explained

Recent headlines have highlighted global bond sell-offs, triggered by the Middle East conflict, rising oil prices, and increased global interest rates aimed at curbing inflation. Higher interest rates result in bond price declines, as new bonds with higher payouts are issued. Consequently, existing bonds with lower interest payments become less attractive to investors.

Consequently, their prices drop, and yields rise to match market rates. This bond sell-off has increased borrowing costs for governments, adding to their interest expenses and draining funds from social and defense programs. Small changes in global interest rates can significantly impact government budgets.

Davy's Aidan Donnelly, a bond market veteran of 31 years, explains that bond yields are always relative to one's starting point. For instance, yields in the US seemed high when he began his career, but they are not particularly high when compared to the 1980s, when Irish government bonds reached 18-20% yields. Bonds are essentially loans, where the issuer (government or company) borrows from investors by selling them fixed-income debt securities.

In return, investors receive regular interest payments and repay the original loan at maturity. Bond yields represent the annual return an investor earns on a bond, which decreases as bond prices rise, given their inverse relationship.

Rising oil prices and inflation have contributed to the surge in bond yields across the US, UK, Germany, and Japan. Governments running budget deficits must borrow more money, further impacting bond yields. Inflation, budget deficits, and increased borrowing for AI investments also influence bond yields. Ireland's public finances are strong, with a projected budget surplus this year.

However, high spending pressures, particularly due to energy cost uncertainty caused by Middle East events and global inflation, are putting upward pressure on bond yields. While Ireland's lending is not directly tied to government bond rates like in the US, as it depends on the ECB's short-term interest rate market, a significant portion of people's wealth may still be exposed to global bonds, potentially affecting their pension values if yields continue to rise.