Public debt dances to the sound of the CPI and interest rates

BarcelonaPublic debt yields have experienced a significant climb in recent weeks, reaching levels not seen in two decades. Fears of inflation and, therefore, the forecast of new interest rate hikes have driven sales of these assets. The fact is that if the cost of living becomes more expensive, the fixed interest paid by a bond loses purchasing power and, consequently, investors sell the securities they hold in their portfolios and demand higher profitability on new issues.

This has forced governments to offer more interest to attract the capital they require to finance their enormous liabilities. In this context, there are those who are more optimistic and claim that there is no cause for alarm until the 10-year debt in the United States, which is the benchmark for the valuation of all assets, exceeds the 5% level. "10-year securities are below the historical average of 5% in the United States," says the general director of GVC Gaesco, Jaume Puig.

On the other hand, there are those with a less positive view and, despite admitting that core inflation —the one that excludes unprocessed food and energy, therefore, the least volatile— is currently more controlled, everything indicates that before the year ends there will be at least one interest rate hike. In this sense, the founder and executive advisor of EFPA Spain (Spanish Association of Financial Advisors and Planners), Josep Soler, considers it likely that the European Central Bank (ECB) will make a move in its next meeting on September 10th. The Eurozone's monetary body could be joined by the United States Federal Reserve (the Fed), which has its meeting on the 16th.

In any case, the new Fed head, Kevin Warsh, could wait for the midterm elections in the North American country, scheduled for November, to raise rates. It should be remembered that Warsh was proposed by the President of the United States himself, Donald Trump, who maintained an offensive against the previous head of the country's central bank, Jerome Powell, whom he pressured to lower the price of money. The current head of the Fed hinted last week, at the meeting held annually in Jackson Hole, in the state of Wyoming, that he could raise the price of money if inflation persists. In any case, he did not give many clues as to when he would do so. And the evolution of core inflation, the structural one, could offer him some leeway to avoid giving Trump the displeasure of facing the midterm elections with an increase in the cost of credit for families and businesses. In this way, a possible interest rate hike in the world's leading power would not take place at the meeting on the 16th, nor at the one on October 28th, but rather at the one on December 9th, once the elections are over.

It is true that inflation has skyrocketed as a result of the war in the Middle East and the rise in oil prices. But the structural one is not runaway in the United States: it stood at 2.5% in July, compared to 2.6% the previous month. The figure is far from the general indicator, which was 3.4% in July. For its part, core inflation in the eurozone marked a rate of 2.4% in August (the general one was 3.3%) and in Spain 2.9% (compared to a general one of 4.3%). In parallel, the Brent barrel—which is the reference in Europe—is around 95 dollars and with an upward trend, but still far from the more than 110 of a few months ago, Puig points out.

Looking at the evolution of the 10-year bond, which is used in the US to set the price of mortgages and credit, this expert adds that "there is still room for an increase". It is currently moving around 4.76%, a few tenths below the 5% reference. In any case, in Spain, the forecast of rising money prices is already being noticed in the one-year daily Euribor, the reference for variable-interest mortgages and the interest at which banks lend money to each other. In August, it approached an average of 3% (2.952%) and during the days of the first week of September, it has not dropped from this level, which had not been seen for two years. The provisional average until last Friday was 3.079%.

Soler recalls that there are some factors that drive the profitability of public debt. The first is the increase in spending by governments in areas such as defense, which worsens the deficits and debt of states. Furthermore, governments have to compete with large tech companies, such as Nvidia, Apple, Amazon, Microsoft or Meta, which need to issue debt to finance the expansion of artificial intelligence (AI). Soler also adds the issuances that large insurance companies have launched to finance an increase in risks on a global scale. All this causes an upward spiral. Issuers must increase the interest they offer in order to attract capital.

In this context, 10-year Japanese debt has traded above 3% for the first time since 1996, with Japan being a country that was accustomed to interest rates close to 0%. Interest rates are rising in all markets. In any case, with the prospects of further inflation hikes and the risk that rising energy costs will spread to the rest of the economy, investors tend to demand higher yields. And this complicates financial costs for governments, which are already high. In the United States, debt has exceeded 40 trillion dollars, which means 120% of its gross domestic product (GDP, the indicator that measures the economic activity of a territory). Investors are demanding an increasingly higher premium to invest in bonds, waiting to see what will happen with the price of money.