Bond yields are soaring to multi-decade highs. What does that mean for

With global bond yields surging to multi-decade highs, a previously mundane corner of the financial world is now a hot topic on Wall Street.

For the average Canadian, it means higher borrowing costs for some products, such as mortgages and auto loans, but also stronger returns on other products, such as other guaranteed investment certificates (GICs) and money market funds.

Let’s start with the basics. When you buy a bond, you’re effectively lending money for a predetermined amount of time to the issuer. That could be the federal government, provinces, municipalities or a private company. Investors are typically paid interest until the maturity date, when they get the face value of the bond back.

So, what’s a bond yield? It’s the annual return an investor earns from holding a bond, expressed as a percentage. After bonds are issued, they can be traded on the open market, causing their prices to shift. When bond prices drop, yields rise. This is because investors get the same interest payments for a lower buy-in price.

Until recently, the global bond market was pretty sleepy. That’s because central bankers around the world kept interest rates at near-zero for more than a decade following the 2008 financial crisis. Now, a growing number of investors see rate hikes on the horizon as central banks look to tamp down sticky inflation.

When a central bank raises interest rates, newly issued bonds offer higher payouts, making existing lower-paying bonds less valuable.

Higher inflation puts pressure on central banks

Right now, the bond market is experiencing a steep, global sell-off. From the United States, to Germany, Japan and Canada, yields have jumped to multi-year or even multi-decade highs.

“What’s going on there? Well, when you see a substantial movement, usually it’s because there is more than one thing happening at once,” Bank of Canada Governor Tiff Macklem said on Wednesday, after the central bank’s latest interest rate decision was announced.

Inflation fears and concerns about ballooning government debt are feeding expectations for the Bank of Canada and its global peers to raise their trend-setting interest rates. 

“Central banks’ tolerance for higher inflation is limited,” said Macklem. “That is causing the market to build in the possibility of future interest rate hikes.”

According to the latest Statistics Canada data, gas prices were a key driver of higher inflation in July. On Wednesday, the Bank of Canada said global oil prices are persistently high, with no end in sight for the U.S.-led war with Iran, which has disrupted seaborne crude traffic in the region. U.S. benchmark oil prices have soared nearly 60 per cent year-to-date. 

At the same time, the bank sees the Canada-U.S. trade war pushing up costs for businesses, which could feed into consumer prices over time. Macklem noted the AI infrastructure buildout is stoking demand for new corporate bond issuance, lowering prices for previously issued bonds. 

“All those things are tending to…