Why when bond yields soar just about everyone's happy

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Suddenly, money is more expensive. Since Donald Trump's US election win 10 days ago, the yields on US 30-year bonds have climbed above 3 per cent and the yields on Australian 10-year bonds have jumped from 2.20 per cent to a peak of 2.60 per cent.

All other things being equal, higher rates are bad for businesses and bad for governments. They push up the cost of borrowing. And they are bad for sharemarkets. There's less reason to buy shares if bonds start offering returns.

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US election: markets grapple with uncertainty

The key outcome of the US election is uncertainty as markets piece together President-elect Donald Trump's policy goals, and how the federal reserve will react. The Age's Peter Martin explains.

But as is often the case when the real world meets economics, things aren't equal. Bond yields are climbing because of a feeling things are about to get better.

Reserve Bank of Australia governor Philip Lowe is deeply worried about the the trade aspects of Trump's economic program. But one thing he isn't worried about is higher rates.

"Yields have gone up 40 basis points in the US, and that's really been transmitted right around the world," he told the Committee for the Economic Development of Australia in Melbourne on Tuesday.

"Part of it is due to people expecting higher inflation, and if that's what's happened, to the extent that that's sustained, that's a good thing."


It would be good for Lowe. He told CEDA his job was "to give to the community an average inflation rate of 2-point-something". Right now it's 1.3 per cent.

Left to his own devices, Lowe might have to push down interest rates to push up inflation, something he doesn't want to do because he wants to hang on to his firepower.

Left to his own devices, Reserve Bank governor Philip Lowe might have to push down interest rates to push up inflation, something he doesn't want to do. Photo: Pat Scala

Help from outside might mean he won't need to, which is why he welcomes Trump's plans to reflate the US by building bridges, roads and other infrastructure and by cutting tax rates, whatever it does to the US budget.

There's room for debate about whether the bond market is right.

Former RBA board member John Edwards believes Trump's infrastructure plan won't amount to much.

"It's exactly the kind of plan you would expect of a Manhattan real estate developer," he says.

"Trump used to look at assets and then ask cities for tax credits to develop them. As [US] president he will offer relatively small tax credits of $US137 billion in the hope they will create assets of $US1 trillion.

"The difficulty is that the private sector will only invest if it can create a revenue stream. It can only do that for types of projects, and it takes a long time to set up the structures that would make it work."

The market finds it easy to believe Trump will reflate the economy because it's reflating anyway. Excluding food and energy, US inflation is now above 2 per cent. It's why US Federal Reserve chair Janet Yellen intends to push up the federal funds rate in December for only the second time since she lifted it above zero last December.

Edwards thinks we've arrived at the end of the worldwide cycle of low interest rates that began with the collapse of inflation in the late 1970s.

The governments that still want low rates will resist. On Thursday, the Bank of Japan announced plans to buy an unlimited number of Japanese government bonds to keep its own interest rates near zero.

For Australia, the more expensive debt will impose an extra burden on the budget, although so far the higher rates have done little more than undo the slide in rates since the last budget in May.

And it'll make plans to borrow to fund large infrastructure projects less attractive, although still more attractive than at most times in the past 30 years.

And to the extent that higher US rates push down the Australian dollar, it'll make Australian businesses more competitive, and kick up inflation. No wonder the governor's relaxed.

Peter Martin is economics editor of The Age



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