The crazy world of bonds, tech stocks and banks

The US government is currently undertaking a major issue of US bonds. (Photo by Kena Betancur / AFP)

It’s not just technology stock investors who start their day checking on the US 10-year bond rate. Australian banks are just as alert to what is happening in this US bellwether market.

In the current environment, tech stocks fall sharply when the US 10-year bond rate increases, and, as happened last night, when the bond rate declines, support pours in for tech stocks.

These two very different investment avenues have become joined at the hip.

Many people are highly leveraged in the tech stock market making it very sensitive to interest rates.

In addition, because returns are so low from yield stocks, investors have turned to speculation, but any lift in yields causes them to switch back.

Australian banks fund a significant portion of their long-term obligations.by borrowing on the long- term overseas markets at interest rates linked to the US 10-year year bond rate.

For the most part, it’s a revolving exercise.

Accordingly, current interest rate costs of banks are benefiting from long-term loans entered into when the US 10-year bond rate was around 0.5 per cent.

Recent loans that are negotiated on the basis based of 1.5 per cent or 1.6 per cent bond rate are obviously more costly.

But the averaging process is extended over many years so it will take some time. before any increase in US rates is directly reflected in Australia.

Last night’s fall in the US 10-year bond rate was significant because it confirms what bond traders had forecast when the US 10-year bond rate was around 1 per cent.

At that time, they expected strong buying to emerge when the rate reached or exceeded 1.5 per cent.

That buying emerged last night at a very significant time because the US government is currently undertaking a major issue of US bonds.

It was important for market rate stability that the global bond market be able to absorb the new bonds without depressing bond prices further and so boosting the yield.

To have the yield come back. from around 1.6 per cent earlier in the week to around 1.54 per cent was a bonus.

In Australia, those banks that borrowed more than their bond buying quota on the US long-term market when the 10-year bond rate was around 0.5 per cent will have a cost advantage in coming years.

Meanwhile, much of the improvement in Australian banking earnings has come via “tarring and feathering” bank deposit holders.

What has surprised many is the fact that even though the rates keep coming down, bank depositors keep taking their punishment on the chin.

Our banks have not been forced to lift deposit rates so they can keep housing mortgage rates down even if the US bond rate rises.

Meanwhile, like tech stocks, equity investments that are closely linked to global interest rates also fall with lower bond prices.

Of course, longer term, the real returns from individual tech stocks will come from their actual performance.