Hi friends. I don't think we can ignore the elephant in the room anymore — the one that started running and has only been picking up speed since. If anything, the trend seems to keep getting stronger: in Japan, the interest rate the government pays to borrow money for 30 years climbed to 4.18% — the highest since Japan first started issuing loans of that length, back in 1999. In the United Kingdom it touched 5.89%, the highest since 1998. In Germany — above 3.8%, a high not seen since 2011. And in the US, whose bond market I wrote about at length two weeks ago, the 30-year rate went back up and touched levels last seen in 2007. Look at the seven largest Western economies as one group, and the average interest rate they pay on their debt is the highest it has been since September 2000.
Before we get to why this is happening to all of them at once, let's stop for a moment on a basic question — who sets this interest rate in the first place? The intuitive answer is "the central bank," and it's true only for the short rate, the one decided in those famous meetings, the one that moves your checking account and your short-term loans. But a government that needs money for ten or thirty years doesn't walk over to the central bank — it issues a bond (that is, a written promise to pay the money back on a set date, with interest known in advance) and sells it in the market, to whoever is willing to buy. The rate it will pay is set right there, by the buyers, and nobody imposes it from above. When the buyers are calm they settle for little, and when they're worried they demand more before they'll agree to lend at all. The mechanics of the rate (or the yield, from the investor's side) run through the bond's price: when there are fewer buyers, the bond's market price falls, and whoever buys it cheap receives the same future payments on a smaller outlay — meaning the yield (the effective rate for whoever steps in now and holds on) goes up. The central bank sets the price of money for one night (that is, for loans that open and close within a day); the price of money for thirty years is set by the market.
So why everywhere, and why all at once? Because the world's lenders are, at the end of the day, one crowd. Take Japan as the example, because it's the heart of this week's story. For thirty years Japan was the world's great lender: interest rates at home were zero, so Japanese pension funds and insurance companies — managing trillions of dollars — went looking for yield abroad, and bought other governments' bonds, in the US and in Europe. Now, with home paying 4.18% for thirty years for the first time, those institutions have no reason to cross the ocean. The money is going home. On the other side of that same move, in London, Frankfurt and New York, a big veteran buyer (the Japanese) has suddenly gone missing — and a shortage of buyers, as we saw a moment ago, means rates that rise. That's how a record in Japan rolls into a record in Britain, which rolls into a record in Germany. The world economy is a set of connected vessels, and money moving in Tokyo moves the price for everyone.
That leaves the question of what spooked the lenders this particular week, and the answer is three things arriving together. The first is energy: the renewed flare-up between the US and Iran over the weekend sent oil prices jumping, and a thirty-year lender fears one thing above all — inflation, which gnaws away at the value of every future payment he is owed. The second is supply: all of these governments keep showing up at the market with more and more new debt, right when the buyers are hesitating. In Britain they calculated this week that every quarter-point rise in rates adds about £2.5 billion a year to the government's interest bill, and in Japan the new prime minister arrives with big spending plans — in a country whose debt is already twice the total output of its economy. The third is the central banks themselves: Fed Chair Kevin Warsh doubled down this week on his pledge to tame inflation, and the market now prices roughly 70% odds of a rate hike — a hike, not a cut — at the meeting in the middle of this month. Put the three together, and the world's lender (that is, the bond buyer) hears one simple message: your future payments are worth less, and the line of borrowers at the door keeps getting longer. So he demands more interest, from everyone. And by my simple explanation from before — more interest means a lower price at the entrance, that is, falling bond prices, and short-term losses for everyone who was already holding them.
In the headline I wrote "almost the whole world." That "almost" is, believe it or not, Israel. While the world breaks records, the Israeli government's 10-year bond trades at only about 4%, less than what the US government pays for the same term. As I've written in earlier letters, the market has priced Israel as a less risky borrower than the US for more than a year now, and the reasons have only strengthened since: annual inflation around 2% (that is, right inside the target), a central bank in the middle of a rate-cutting cycle, and a strong shekel. But no confusion here: economists in Israel will tell you that the single biggest driver of Israel's long-term rates is the direction of yields in the rest of the world, above all the US and Europe. When the whole world makes money more expensive, the Israeli exception isn't immune — it just gets a discount, and that discount may turn out to be temporary. Meaning — this gap cannot keep widening forever. At some point it will start to close, from one of two directions or from both at once: either yields around the world stop rising (and start falling), or Israel's yield climbs toward the rest of the world, or a bit of both.
And wait — what about Friday's jobs report?
On Friday the US Bureau of Labor Statistics published the August jobs report, and it was the kind of surprise we'd forgotten existed: 162,000 new jobs, when economists expected only about 55,000 — the strongest month in five months. The unemployment rate held at 4.1%. If you've been reading me for a few months, you'll remember that in Letter #20 I explained that the first release of this report is really a draft — it's built from a sample of businesses, not a count, and gets revised twice — and that back then the revisions leaned systematically downward. This time? The revisions went up: June and July together were revised 55,000 jobs higher. The mechanism hasn't changed, and the first print is still a draft — but the direction flipped this time, which is exactly why you read the trend and not a single number. One layer under the headline, a familiar story continues: the information sector — software, computing, media — lost another 23,000 jobs, while restaurants and local-government education led the hiring. That split, between a shrinking knowledge economy and service industries that keep recruiting, is a process I wrote about half a year ago, and it keeps grinding on quietly, report after report. Why does any of this belong in a letter about interest rates? Because a stronger-than-expected job market is precisely the reason the Fed is in no hurry to cut — and may even hike — and the market indeed raised its bets on a hike the moment the report landed. Friday's jobs report didn't cool the trend — it simply poured another drop of oil on the fire.
What this means for your pocket
If you have money sitting on the side, then on the face of it, the opportunity I described two weeks ago has only improved: more than 5% a year, guaranteed for thirty years, from what is still considered the safest borrower in the world. A British or Japanese saver is being offered the highest rate an entire generation there has ever seen. But — and it's a big but — what looks like an opportunity today can look, a few months from now, like a trap for the suckers who walked in too early.
If you hold stocks, the mechanism I explained two weeks ago is still at work, and in the unpleasant direction: when the safe alternative rises, companies' future profits are worth less at today's price. Same company, same profit forecast — lower price. That pressure doesn't go away as long as yields stay up, and it is exactly why markets have been jumpy these past few weeks. As long as bonds don't let up on their march toward higher yields, the stock market won't be able to lift its head.
So what do I think about all this? I have to tell you — I don't have an unequivocal answer. The trends and forces at work here are not pulling against each other. And they are strong. Meaning, whatever pushed yields up hasn't gone away, and I don't see how it goes away anytime soon (except for the war with Iran, which can swing either way on any given day). The world's debt is still heavy, the deficits (above all in the US) are enormous, the Japanese are still wrestling with structural problems and debt far above their output — and all that before the new technology companies come to market to finance themselves and join the sellers' side. Tempting as it is to buy now and lock in 5-plus percent for decades to come, my gut feeling is that it's better to wait outside a little longer, because what started as rain can accidentally turn into a flood. Let's hope not, and either way —
We shall see.