How do we interpret the turmoil on global markets? US longer-term borrowing costs have touched levels not seen since 2007, the Federal Reserve has pushed up its key interest rate – against the wishes of US president Donald Trump – and international markets don’t seem to know which side is up.
What does this mean for Ireland and for Irish households and do we need to be worried?
Why is it happening?
Interest rates are rising for two fundamental reasons. One is an expectation that inflation will now climb again mainly because of higher energy costs, with no end to the Gulf crisis in sight and worrying signs elsewhere, such as in European gas markets, and food costs.
News here is likely to ebb and flow – wholesale energy prices rose sharply over recent weeks on a string of bad news, though oil eased on Thursday on hopes of an opening of a key Saudi oil pipeline.
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The second reason is competition for investor funds. Governments across the world have borrowed heavily over the past years and continue to look for cash to fund budget deficits and renewal of expiring debt.
[ Irish borrowing costs hit bailout-era highs as investors up bets on rate hikesOpens in new window ]
Meanwhile major tech companies are also borrowing billions to invest in artificial intelligence (AI) infrastructure, hugely increasing the demand for cash from the private sector. They are competing with government for the cash investors have to allocate and this has pushed up interest rates.
“The so-called hyperscalers are out in the market raising funding, and so the competition for capital is real,” according to US Federal Reserve Board chair Kevin Warsh, speaking this week.
Morgan Stanley has estimated that AI-related borrowings could reach $570 billion (€496 billion) this year alone, with the five major “hyperscalers” – Amazon, Alphabet, Meta, Microsoft and Oracle – responsible for more than $250 billion of this. They are no longer able to fund spending through their cash flows and so have to borrow.
The resilience of the world economy to the many recent pressures has also affected the bond market – lower growth would have pointed to lower interest rates by cutting the demand for borrowings.
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So this is all normal then?
No. Not at all. The scale of change has been notable and unusual. There has been a nasty reversal in government bond prices in recent weeks in markets across the world, led by the US, pushing interest rates – which move inversely to bond prices – higher.
The scale of this is not normal. And the move in the US 10-year interest rate – dubbed by the Financial Times as the world’s most important interest rate, as it is seen as a benchmark – is notable. It has risen from 4.7 per cent a month ago to about 5 per cent – having reached 5.041 per cent, its highest level since June 2007, on Tuesday.
Hawkish comments by Warsh after Wednesday’s interest rate increase is likely to keep bond markets on edge, particularly for short-term borrowings.
But this is a US thing, isn’t it?
Government borrowing markets worldwide have been hit, mainly for the same reasons – fears of higher inflation and competition for funds. Irish longer-term interest rates are at levels last seen in 2013, with the 10-year yield over 3.6 per cent on Thursday. You could take a glass-half-full or half-empty approach here.
Borrowing costs are at their highest levels for many years and this has implications in the longer term for the public finances – there is no going back to the super-low interest rates which applied from after the financial crash until after Covid-19.
So the cost of borrowing for Ireland will gradually rise as existing fixed-rate debt falls to be refinanced at higher costs. Frank O’Connor, chief executive of the National Treasury Management Agency has warned that the cost of making repayments for Ireland on the national debt could rise from about €3 billion this year to €6 billion by 2030.
The more optimistic view is that Irish borrowing costs remain low by international standards. German 10-year rates – the euro-zone benchmark – are at just over 3.5 per cent while French and Italian rates are in the 4.3 to 4.4 per cent range.
[ Bond sell-off accelerates globally as investors bet on interest rate hikeOpens in new window ]
A key issue to watch in international bond markets in the weeks ahead is whether problems emerge for any country trying to raise funds, leading rates to spike higher.
But the equity market keeps rising?
So far, yes. Higher bond interest rates can put pressure on equities through a range of channels. For one thing, investors wanting to put money into US dollar assets can now make a safe bet by putting them into treasuries (as US government bonds are known) at a risk-free interest rate of more than 5 per cent. This raises the bar in terms of investing money in equities.
Higher interest rates can also slow economic growth, hitting company profitability – and can also make it more difficult to countries to support their economies through higher spending.
All that said, for now the hopes that major companies can benefit from AI – and that the technology can lead to a general rise in productivity across economies – continues to support equities. So does the reasonably positive growth story in many major economies, itself supported by massive AI investment.
And the recent US earnings season – in which companies reported second-quarter results – saw more than eight out of 10 beating market estimates and average profitability running more than 25 per cent ahead of expectations.
All this is supporting stock markets, despite high valuations and uncertainty about who will win the AI race and the wider economic and social implications of the technology.
But add in the uncertain geopolitical backdrop and it all points to a nervous and volatile time for investors.
What are the wider messages for the Irish economy and household finances?
The main point is the recent change in the expectations for interest rates and inflation, which is pushing short- and longer-term interest rates higher.
This threatens another twist to cost-of-living pressures via higher energy costs for households, general pressures on inflation in areas such as food and higher interest rates. We have already seen higher prices at the pumps and a big rise in wholesale gas prices now threatens higher home heating bills.
Expectations here have changed markedly in the space of a few weeks, partly due to the Gulf crisis. Before the last European Central Bank interest rate rise, analysts on balance did not expect another increase later this year. Now they believe another rise will come in December and quite likely more next year. US rates are also expected to increase again.
All this signals fears about higher inflation. And it means the main Irish banks are very likely to follow the latest ECB rise with moves of their own - beyond tracker mortgages, which adjust automatically - with more now likely to come in 2027. Even if the scale of this remains unclear, it is important for the mortgage and housing markets.
The wider implications in financial markets will take time to play out. Higher US interest rates may push up the US dollar, putting pressure on some other countries to follow.
The Bank of Japan is widely expected to push up its borrowing costs on Friday. An unstable situation threatens upheaval in financial markets, particularly if there is a trigger such as another swing higher in wholesale energy prices.
For households, pension funds which typically invest in a range of assets will have gained from higher equities but been hit in recent months by falling bond prices. With funds for those closer to retirement tending to be more invested in bonds, many will see lower valuations.
For the budget next month, the outbreak of higher inflation and the renewed threat to energy prices poses real problems. Unless this eases, the complications of delivering a package to address the cost-of-living pressures are really significant.
