Why you should care about US bond yields

ABC Listen, podcasts, radio, news, music and more. Hi, it's Sam Hawley from ABC News Daily. The podcast that brings you one big story affecting your world each weekday in just 15 minutes. These glasses are always on. They have microphones, they have cameras, and they basically become face mounted data vacuums. Join me for ABC News Daily. Find us on ABC Listen. So the question dear listeners, is this red lights flashing? The yield on a 30 year US Treasury bond is now the highest it's been in nearly two decades. So why are investors demanding a higher return in exchange for lending money to the US government? And why should Australians be paying attention? And as Australian property prices fall, what can we learn from our Commonwealth cousins, New Zealand and Canada about property bubbles and the risks of it popping? Welcome to ABC Business Daily. I'm Carrington Clark. And I'm the inventor of the ABC's Chief Business Correspondent. Ian, thank you so much for joining me. Let's start with what's happening with US Treasury bonds. Now the 30 year Treasury bond is kind of seen as the gold standard when it comes to risk-free investing. And we've now seen it hit a 19 year high. So this means that the cost of borrowing for the US government has gone up. But it also means that the cost of borrowing is going up across the board. And so how concerning is this when you look at it? It's been steadily growing over recent years. But obviously pushing up to a level of 2007, I think starts to concern people. Should we be really worried about this or is this just markets pricing at a time when you've got, for example, artificial intelligence companies asking for a whole bunch of money to fuel their investment? Is that what's going on or is it concerns about inflation and about the huge amount of debt that the American government is now carrying? That's the primary problem, the US government debt. And that's what people have focused on. And it's not just us talking in a room in the middle of Sydney. It's a global phenomenon where people are really quite concerned about what is happening with the US government debt and the amount of money that it's spending. The deficits it's racking up. And I guess the seemingly endless road towards greater debt. There doesn't seem to be any kind of plan to rein it into the future. Now when Donald Trump first, when he became president in late 24, early 25, there was a lot of talk about the US government debt back then. It was around about $32 to $33 trillion US dollars. And there was a lot of concern about that. Well, it's just gone to $39.1 trillion. We've got a huge amount of spending going on in the Middle East over this war. And of course, Pete Heggseth, the Defense Department secretary and the president have both basically fronted up to Congress demanding more money for defense. So there seems to be no end in sight to try and solve this problem. And when you have debt blowing out to this kind of extent, how do you fund it? And this is no ordinary country. America is the US dollar, is the global reserve currency. It is the bedrock for the global financial system. And so if you've got a massive blowout in debt with no obvious plan on how to repay it, it is a problem. Put this into a bit of perspective as well. The interest bill on that debt has now just shy of a trillion dollars a year. And that means it's become the third largest component in spending. So the debt is starting to snowball and actually take over the government's finances and it's off. And this is what is concerning everybody. So we talk about US Treasury bonds as being effectively a risk-free asset. Because the concept is the American government is never going to go bankrupt. It's never going to not repay its debt. Do you think people are starting to question that basic understanding or is the fact that the US dollar is still the backbone of the global economy mean that it would be impossible for the US government to do as other governments have done, which is effectively say, actually we can't repay the debt that we owe to people we've borrowed from. For as long as everybody believes that it can continue on, the financial alchemy that exists around all this remains in place. But as soon as the doubts start to grow to a point where people are going, how do you finance this? How do you repay it? This doesn't seem to be a way out. And sometimes those moments come very quickly and very suddenly and causes a crisis, which we saw back in the global financial crisis. So one of the arguments for Donald Trump's tariff regime seemed to be that actually this might be one of the few ways that America can start raising revenue in order to start paying down this debt. Now economists obviously buy and large hate tariffs because they think it just pushes up the costs for consumers, because it's pushing up the costs of things that are imported into the country, makes it more expensive. But it can be a source of revenue for the Treasury. And Donald Trump obviously is quite convinced that this is a good thing for the country. The problem is the tariff regime has been knocked down a couple of times. He's tried to find another way around it yet again, but it's not going to raise as much money as the original setup that he offered on so-called Liberation Day. Is that one of the few solutions that actually do think Donald Trump does actually recognize how big a debt problem America has? And that's why he's going down the road of tariffs. Or do you think he's relatively blind to how big a risk this actually is? Or is this one of the few things that Donald Trump understands as someone who's involved in property that interest repayments are something that hurt you and he wants to somehow bring it down even if he does seem intent on spending more? I think if he wanted, I mean what you're talking about here is two separate things right when it comes to financing. You're talking about external financing deficit. We're talking about, and you're talking about the internal. So there's the trade deficit that is raking up at a huge amount. And that's what I guess they're trying to fix there along with a fiscal deficit in terms of government spending. Now if he was really really concerned about this and I guess his push towards making NATO countries pay a greater contribution towards regional defense. And now South Korea again he's talking about the fact that they're not paying enough for their defense and so he wants to see them to shoulder more of the load. But then at the same time he barks about an illegal war which then results in a massive blowout in spending. He also reorganizes the tax system to ensure that very very wealthy people don't pay a lot of tax. And that big beautiful bill that supposed reform, that's the most ever used word in the English language reform, especially when it comes to tax, that reform has cost the US budget dearly. So if you were really concerned if you really did understand the financing of all this, you would not have done that. You would also have done something very much different in the Middle East rather than start a war which has run down all of your armaments at an extraordinary level. You have at the same time this investment booming artificial intelligence we're seeing it here in Australia as well obviously with the expenditure and data centers. But particularly in the United States these big AI players originally a lot of the money was coming from people basically buying into the companies getting equity in the businesses increasingly though they're looking to get debt financing in order to fund this expansion. Is that part of the story here that you've got these big tech companies asking for money and therefore the same investors demanding more from Treasury to lend to the US government. And is it sustainable? Do we have enough cash to actually fund all these things at once? Well, cash can be created and it can be created on a whim. I mean the theory behind money is actually quite complex and it does rely on just faith. It's almost like a religion really. But you're absolutely correct that the source of financing for this expansion has shifted from cash flow from profits from internal profits from the likes of Alph Meta and Alphabet and Microsoft. They were funding all of these things just through the profits are making and they're making enormous profits on their original businesses. Now they've kind of got to the point where they're using up all their free cash flow and they've had to resort to raising cash and that may and they're still spending at an extraordinary pace. So yes, this is all coinciding this demand for cash this demand for investment. It's coinciding with an incredible demand increase in demand from the US government and the US government demands are you know in large part driven by the fact that it's dead is so large that it's got to raise money to pay the interest. So obviously here in Australia there's a huge focus every six weeks when the reserve bank decides what to do with interest rates and we see the immediate almost immediate impact on home loan rates if they hike interest rates but a major component of how much people pay how much interest people pay on their home loans is what's happening with long term debt. So this is going to hurt Australians as well directly isn't it's got one hand it's going to raise the cost for our banks here who source money from overseas and they're also competing with what the returns people can get from the US government effectively. But also if we see more people chasing higher yields in the United States they want to buy US currency and that can lead to lower value for Australian dollars that also makes inflation more problematic here in Australia right so this is this is impacting us directly even if it feels like it's something that is mostly. about what the US government is doing, this has the power, the impact on the Australian economy and on how much people are paying here. Yeah, look back, what mid or early 1980s before financial deregulation, Australia was pretty much a closed system when it came to banking. You know, people put X amount of dollars in the banking savings and the bank lent that money out in loans. A lot of it for home loans and business loans, right? And so the interest rate was determined by the amount, the supply of money that people were giving to the banks and then they were lending it out. Now, after deregulation, we saw that continue for a little while until, I guess, the mid to late 90s when you saw all of those smaller non-bank operators like there was Mark Borris's, one was a call, Wizard, that's it. And, you know, Aussie John with his loans and what they did was they decided, they looked at the Australian market and went, wow, look at the margins these banks are making on these loans. We can go off to America and actually raise money really, really cheaply, bring it back here, undercut the banks and really carve out a big slice of the home loan market. That's exactly what they did. You know, of course, they eventually were snapped up by the big banks, but all the banks then started doing the same thing as well. So, you know, with deregulation, they could actually go to America, go into those wholesale credit markets, raise money there directly and bring it home. And so, we are now absolutely tied to what happens in US credit markets and also European for that matter. So, our banks often just, scour the world for the best deal that they can get. So, we are plugged into a global system here. So, when interest rates do rise in America particularly because it's the world's biggest economy and it's the reserve currency, the US dollar, when interest rates rise here, they rise around the world and they directly impact us. So, over in the United States, most people when they take out a home loan and get a locked in rate for the duration of their home loan. They take out these 30-year mortgages, which obviously you can directly link to what you're getting on a treasury bond. Australia's different situation, the vast majority of people are on a variable rate for their mortgage. And so, this is going to have a more direct impact in some ways, isn't it? Australians who have these floating variable mortgages, it's going to hurt Americans who are trying to get a new home loan. This forces up the rate that they're going to pay. The people have already locked in. It doesn't impact as much. But this is going to have an impact. And what do you think it does do potentially to their calculation for our reserve bank when it comes to interest rate high? Well, this starts to put enough pressure on that perhaps a rate rise here is less likely. Is that how we should understand this calculation? That's really hard to say. But I mean, Australia is the most sensitive country in the world to interest rate movements. And you're talking about most people have got variable rates. I think it's, it is more than 50%. But even if you've got a fixed rate, I mean, what's your fixed rate? If you're lucky to get four years, five years are almost unheard of. So, most fixed rate loans at one, two, three years, that's really not a long-term fixed rate. And so, whenever interest rates move, the banks change the repayments for household here. And so, you feel it immediately. You feel it within weeks. So, if interest rates rise, you've got less money in your pocket almost straight away. In America, if interest rates rise, well, if you were thinking of buying a house, you'd be going, well, I might just wait a year or two. Because, you know, why should I lock myself into a 30-year loan at a higher rate when it could be cheaper next year? And so, you tend to see, I guess, it flows through directly into demand for housing, but not so much into the direct impact on household budgets. Yeah, because it's not impacting how much people are repaying at the moment, but yes, have a more impact. And so, that impacts the amount of money you've got to spend, which has a direct flow through to the broader economy. So, we have also, in recent times, seen some pretty extraordinary interventions when it comes to what's happening in Japan. I mean, is this all interconnected? And again, like you've been watching markets for a long time, and we have to always be careful about catastrophizing. But when we start looking at 2007, we can think back to the GFC, do I use starting to get concerned about what we're seeing and how this might compare to other points in history where cash started to get a bit tight when markets started to look a little bit concerned? But at the same time, that's offset by seemingly endless optimism when it comes to artificial intelligence and the huge profits that they might be able to make people. The most concerning thing I guess about the US budget situation and the debt is that it doesn't appear, it's not sustainable in the long term. I mean, as I said, just last year, the debt was at 32, 33 trillion, and people were concerned about that. It's now approaching 40. It's rising at a very rapid rate, and there's no clear plan to either put a lid on that or to, you know, reign back in. Now, there's an offsetting thing here. If your economy grows at a faster pace than the debt is growing, then yes, you can keep the overall size of the debt is not the problem. But the economy, the US economy isn't growing fast enough to keep that debt in its tracks. And so, yes, it is a concern. It's not absolutely critically dangerous, although US debt to GDP, I think, is around about 125 or so. And if you recall, after the global financial crisis, everybody was absolutely melting down, because Greece had a debt level of around about 130, so not too far above that level. I noted Martin Parkinson, the former Secretary of Treasury, was talking about the Australian economy recently. And he said, one of his concerns was, we're actually in a pretty good period, right now, right? Like the globe's on its recession. But the budget isn't improving at the rate that you want it to be improving, because what you want is to be in pretty healthy surplus, you know, low debt, if not, you know, no debt. Just in case things start to go wrong, so you've got firepower available to you to try to get you through a period where it gets a bit rocky. And I think the same is true in America, right? How is it that the budgetary position is deteriorating at a time when economic growth in the US is pretty strong. I know. A huge investment. And yet you're building more debt. What happens if we do hit the skids? Like they don't have the firepower available to them in order to try to correct that? It will look at our debt levels of what in the 30s, right? Around about the mid 30s, 35% to GDP. And America, it's above 125 or so. I mean, Japan, 250, right? Japan's always had huge amounts of debt as compared to its economic growth. And primarily because of its, I guess, that it's still never really recovered from that boom. Well, the bus that followed the 1980s boom, the 70s, 80s boom in Japan, is never fully recovered from that. And you mentioned earlier about the Yen and the US government intervening in the Yen to try and prop up the value of the Yen. I guess one of the concerns globally is that China has started to sell down its debt holdings in US government debt. It was the biggest owner of US government debt, the biggest supporter of it. It started to sell it down. When a country or a large player sells down US government debt, that pushes interest rates higher because you're selling, so somebody else has got to pick up the bonds that are out there in the market. And to do that, you have to offer a bit higher interest rates. Now, Japan is the. And they're inverse, right? The prices inverse to the yield, so therefore if they're selling off, there's less demand, so they're pulling it down and therefore the yield has to go up. That's right. Now, Japan has emerged as the biggest owner of US government debt. And the Yen has dropped dramatically in the past few years. I was in Japan in 2019. I was getting about $71.72 Yen to the dollar. You can get 115 now. So the Yen has really dropped quite dramatically. And the concern is that Japan has so much debt out there, outstanding, that if it needed to raise money to prop up its economy, it could sell off US government debt. Now. Fawcing yields even higher. Hence, the US government backing Japan and the Bank of Japan. In self-interest. Yeah. Yeah. To make sure that they're not going to be paying more. Yeah. And that you don't have some kind of ripple effect or something worse than a ripple. Washing through the global financial system. And again, what happened after the Liberation Day tariff announcement? Yeah. What seeing to actually spook Donald Trump wasn't what was happening in the share market. No. It was what started to happen in the bond market. And obviously he was listening to his Treasury Secretary among other people saying this is starting to get concerning. And then we saw him pull back from at that point that very kind of vicious wall with China, where they'll just keep jump. They kept pushing up tariffs between the two of them. That was causing concern in the bond market. And so that was what pulled it back. Yeah. I think talking about Japan and talking about what happened during the 70s and 80s. And what we saw with the collapse of its property market. You know, people talked about that period where what was at one square mile of Tokyo was worth the entire value of California or something. Yeah. It was the palace. It was exactly. It's on a couple of hectares of land, but yeah, it was worth more than the entire everything in California. Yeah. And so this was one of those examples, or I'm kind of, I guess, with the Irish property collapse as well, where you saw this extraordinary bubble in value when it came to property and when it popped, it caused huge amounts of problems across the economy. Now again, we have to be careful. We're not suggesting that Australia is in that state, but you've done this piece of analysis looking at the example of what's happened in New Zealand and Canada to economies of are pretty similar to Australia, obviously a shared history when it comes to the Commonwealth, pretty similar forms of government, both of whom saw their property markets go on an absolute tear, kind of post pandemic, and both of whom have seen pretty major corrections in recent times. Australia is kind of early days with the housing minister called it a property correction, but we have to be careful about terminology here, but it's obvious that there is downward pressure on property prices here. Is Australia going to follow what happened in New Zealand and Canada? What are the similarities? What are the differences? Well, there's a couple of major factors that influence property prices. I mean, you know, forget the demand supply. We all know that, but I guess there's interest rates clearly. There's also population, the size of the population. Now, from about 2000, early 2000s on, we really opened the floodgates here when it came to immigration, and that was a major factor behind the rising value of Australian real estate. That and the tax measures we had in place, which really encouraged investors. Now, interest rates have risen quite dramatically in the past five years or so. We're looking now at curbing immigration. All three potential parties of government, one nation, the coalition, and labor all seem to be suggesting they're going to be lowering immigration. That's going to be their announcements. At different levels, one nation wants a massive cart coalition, maybe slightly less, and maybe labor slightly less than that again. And the third factor is we've just basically closed off a lot of those those investor tax loopholes or incentives that gave that really boosted property. So you got three factors there that are all starting to turn at the same time. And this is I think where everybody's got to be very careful. The government, the Reserve Bank, in how they engineer this and how they cope with this downturn. Because if you look at New Zealand, New Zealand did clamp down a little bit on investor home loans. They also really jacked up interest rates to a point where there was sent the economy into recession. They were lucky that they've got a big neighbor just to the west of them. Because when the economy went into recession, a lot of job losses, a lot of younger New Zealand has just packed up and left and came to Australia. Yeah, big neighbor to the left of them, but also one where they could easily move to. The agreement is basically you can move pretty freely between the two countries and work almost immediately once you've arrived. So that was really quite advantageous to New Zealand. So New Zealand's unemployment rate did not go to really extreme levels because if you were fairly young and you lost your job, you just head off to Sydney, Melbourne, Adelaide, wherever you want to go. And so that's what happened. Canada's unemployment rate rose. Well, it's about 7%. Now some cities got an unemployment rate of about 9% at the moment. So really quite serious unemployment levels there. So that gives and Canada also pushed their interest rates much higher than Australia did. They peaked at about 5%. The Kiwis went to 5.5%. We were at our highest level now at 4.35. So we were much lower than New Zealand. And we avoided a recession as a result of that. But we are winding back on these other programs as well. When I was in America, the immigration debate in Canada was very similar to what we're seeing currently in Australia. They had a huge amount of international students coming to the country. There had been major population growth in recent times. Vancouver was one of the hotspots for this, but really across all the major cities. And there was a real shift despite the fact that you still have a left of centre government, which is now led by Mark Carney, but was previously under Justin Trudeau. There was a marked shift in all the one level of immigration. They cut back immigration levels quite substantially in just a bit over two years ago. And so you had that real boost in interest rates after Russia invaded Ukraine in the post-pandemic era and then quickly followed up by severe cutbacks in immigration. And so that has really crimped demand for for housing in Canada. And so to the point now where Canadian marketer has dropped around about 20%, that's after inflation. So if you want to include inflation, the inflation, it's much higher. And so a big drop there. And to the point where a lot of property developers are now in trouble, and you've got the Prime Minister Mark Carney trying to come up with some kind of solution to put a bit of a floor under the market. Now obviously, immigration, raising immigration isn't on the cards. So they're looking at actually buying properties from developers and creating some kind of a national housing scheme or an affordable housing scheme. And I think what it also does is as soon as you see a pretty substantial downturn in property prices, it goes from being this like one way bet where everyone thinks all you need to do to build wealth is to buy a property and you get real estate agents saying, the best time to buy was just say that second best time to buy is now and it's a one way bet and of course you need to buy to people saying, wait a second, I know someone who lost 20% of the value, there was hundreds of thousands of dollars on the value of their home. And suddenly people are much more cautious about buying and obviously that has ripple effects because the people who own property, they no longer feel as wealthy. So maybe they're outspending less money in the economy, that leads to lower growth as well. And potentially it leads to bankruptcies in the construction industry or all these industries that are connected to that booming property market. Which adds to unemployment. And in terms of demand, I mean why would you go and buy a place now if you thought it was going to be much cheaper in six months time? But you've got what we're seeing currently in Australia. Yeah, so you've got a massive drop off at the moment and we've seen all four of the big banks come out in the past week or so with numbers that essentially show applications for home loans from, you know, owner occupies are down anywhere between 10 and almost up to nearly 20%. And investors higher than that. So you're watching people going, well, the market's going to come off. This is so difficult though, right? Because on one hand, what we've been told by economists for such a long period is we were overly investing in property. That we all basically all the spare cash people had or not spare cash, but they would basically leveraging up to the eyeballs in order to invest in the property market. Now that's an opportunity cost. That money can't be spent on building factories or building businesses, etc. So there is an obvious public policy benefit for there being less, for housing to be less expensive. That means it needs to come down in value. But in the short term, it can get into dangerous precarious territory. It's not the trend. It's the speed. Yes. Yeah. Yeah. Yeah. Yeah. It's the way the change takes place. If it's really gradual and you don't really notice it, it's not a problem. But if it suddenly all falls off a cliff, everybody panics. And this is where you've got to try and manage expectations. And so I think you might find when it comes to immigration, labor will probably push, I mean, they are a party that there's always favoured immigration, but all look all the coalition is always favoured immigration in a big way as well. Because the business counts of the business lobby groups all love lots of people coming in. Makes a lot more cost. Yeah. Yeah. So, yeah, I think there will be a lot more cautious on, you know, you don't want to have three levels or acting against property at the same time and creating a situation that potentially could get out of control. Look at China as well. China's housing market fell off a cliff. And you've had enormous social problems. It's really ricocheted through the economy there. And it is still a problem. So, you know, you've just got to be very careful about how you manage these things. And before we let you go, we do have a listen and question in the inbox about bankrupt businessmen, John Adjimus, who you've been writing about and who you spoke about with Steph on the podcast a couple of weeks ago. Rob is asked, how can John Adjimus and people like this have a property re-valued by so much as we're shared in this podcast immediately after going through a purchase? Surely the purchase process defines the property value. Why are the financial teams allowed to do this? Is it just his team putting together a fresh business case to justify what he thinks the property could be worth in the future under his guidance? It's a great question. And I reckon this is going to be a something that the, you know, liquidators will be looking at and possibly even are asick, you know, the role that re-valuations play in these kind of systems. If you look at what he did, what John Adjimus did, he would buy a property for $5 million and then re-value it up by about four or five, six times that value. Right. And then immediately say, well, I've got all this extra capital here. It's collateral and go and borrow more money. Now the way he was doing it was he would say, this is a property that's been run down. I've got it on the cheap and we will be spending a, you know, a lot of money to do it up. And when it's finished, that's what it's going to be worth, except that he wasn't waiting till it was finished. He was doing it before they even started the renovations. We won't name the, the firm responsible, but I think they are going to be up for some questioning. Fascinating. That is it for today's episode of ABC Business Daily. We're going to be back with another episode tomorrow to make sure you get it as quickly as it's in the feed. Make sure you're following us on ABC. Listen, or wherever you get your podcasts. And if you'd like to send in a question, just like that excellent question from Rob, you can email in to ABC Business Daily at abc.net.au. Catch you next time, Ian. See ya.