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Why should you care about the bond market?

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The last week has seen a significant sell-off in the bond market. We explain why it matters for you and your investments.

What’s happened?

Bond markets are worried that higher inflation and improving economic growth will prompt higher interest rates. Central bankers, including Bank of England governor Mark Carney, have been clear that markets should not assume lower interest rates indefinitely. This means that bond yields – in essence this is the price companies and governments have to pay to borrow money – have risen and that prices have fallen. This is bad news for governments and corporates, both of which will have to borrow at higher rates from now, but what might it mean for your finances?

Why is this a problem for investors?

Bond markets are usually seen as a ‘safe haven’ for investors. You buy a bond, you get an income and you get your money back at the end. If you buy a bond directly, this is still what happens, providing the company issuing the bond doesn’t go bust.

However, most people don’t buy them directly, they buy them via a collective fund such as a Strategic or Corporate Bond fund. These funds buy and sell bonds in the secondary market. Here, pricing works slightly differently. In the last financial crisis, some corporate bonds saw price drops of as much as 20% in the secondary market. If people start pulling money out of bond funds, fund managers are forced to sell at these lower prices. That’s bad news for anyone who holds a bond fund as a safe investment.

Why is it a problem for homeowners?

Higher bond yields have a number of knock-on effects. Mortgages are priced from the gilt yield, and if gilt yields rise significantly, mortgage rates will go up. Central bankers are likely to tread carefully; they are well aware that UK households are fragile and many could not support a significant rise in mortgage rates.

Even a relatively small rise in rates could have an impact on the housing market, and on consumer spending. Higher inflation has already left people with less money in their pockets.

Good news for savers

This could be good news for savers. Saving accounts are usually influenced by bond pricing. If yields rise, savings rates might climb higher, up from historic lows. It may also mean that bond markets start to provide a decent source of income again. For some time, the income available from ‘safe’ bonds has not beaten inflation, but this may change.

Good news for holidaymakers

Finally there has been some respite for the pound. International currency markets are sensitive to the machinations of central bankers. Sterling has risen from post-General Election lows against both the Euro and the Dollar, which will make your holiday money go a little further.

Putting it in perspective

The bond market has been in a near 30-year bull run. This means that the income available from government bonds has been dropping for almost all that time. Investment specialists have been predicting the end of this bull run for some time and it has not materialised. This is a relatively small blip and may not last. The sell-off in the bond market may change the landscape a little, but material change looks unlikely.

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