Why Should a South African Care About US Bond Yields?

When most people think about global markets, they picture flashing stock prices, Wall Street traders shouting into phones, or the latest drama involving a tech billionaire.

Very few people wake up in the morning wondering what the US 10-year Treasury yield did overnight.

And yet, if I had to choose one number that quietly influences your retirement savings, your mortgage rate, the rand in your wallet and even what the South African Reserve Bank does next, it would probably be that one.

The bond market has a reputation for being boring. Unfortunately for all of us, it is also incredibly important.

So, what exactly is a US Treasury bond?

Imagine the US government needs to borrow money. Instead of walking into a bank and applying for a loan, it issues bonds. Investors lend money to the government and, in return, receive interest payments and their money back at a future date. Nothing particularly exciting there.

What makes US government bonds special is who the borrower is. The United States is the world’s largest economy and the largest issuer of government debt. As a result, US Treasury bonds have become the foundation upon which much of global finance is built.

For decades, investors have viewed them as the closest thing markets have to a risk-free asset. Not because the US is literally risk-free, but because the likelihood of it failing to repay its debt is considered exceptionally low.

That means Treasury yields have become the benchmark against which almost every other investment is measured.

The most important number in finance

Investment professionals often refer to Treasury yields as the “risk-free rate”. The concept is surprisingly simple. If an investor can earn 5% by lending money to the US government, why would they invest in something riskier unless they expect a higher return? They wouldn’t.

That means every other investment in the world has to compete with Treasury yields. South African government bonds, listed property, equities, private equity, infrastructure projects, venture capital and emerging markets all need to offer a higher expected return to justify their additional risk.

In finance, we call this the “hurdle rate”.

When Treasury yields rise, the hurdle rises for everyone.

Why markets become nervous when yields rise

For much of the period following the Global Financial Crisis, interest rates and bond yields were unusually low. Investors searching for returns were pushed further out on the risk spectrum into shares, property, private markets and emerging economies.

Today, the picture looks very different. The US 10-year Treasury yield has climbed above 5%.

And this is where the numbers can be deceptive. Moving from 2% to 5% doesn’t sound dramatic at first glance. But when the return available from the world’s benchmark risk-free asset more than doubles, investors inevitably start reassessing what they’re willing to pay for everything else.

There is an old saying on Wall Street that higher interest rates are gravity for asset prices.

The higher the return available on safe assets, the harder it becomes for riskier assets to justify expensive valuations. That’s why bond market moves often have such a profound impact on share markets, even though the bond market itself receives far less attention.

In many respects, the bond market is often the market that tells the stock market what to do.

But I’m sitting in South Africa. Why should I care?

Because money has a passport. Capital moves around the world looking for the best risk-adjusted return.

When investors can earn attractive yields from US government bonds, they often require considerably more compensation before investing in riskier markets. That includes South Africa. When global money flows back towards dollar-denominated assets, the rand often comes under pressure.

And that’s where this becomes personal. South Africa imports a significant portion of its inflation. We buy oil in dollars. We import machinery, technology and many manufactured goods from overseas. When the rand weakens, those imports become more expensive. When oil prices rise at the same time, the inflationary impact becomes even more pronounced.

Most South Africans think of the rand as a report card on how the country is doing. Economists tend to think of it as one of the main channels through which inflation enters the economy.

The connection to South African interest rates

South Africans often ask why the Reserve Bank can’t simply cut interest rates to help consumers and stimulate growth. The reality is that every move a central bank makes affects something else.

If US yields rise sharply and the rand weakens, inflation risks can increase. Higher fuel prices feed through the economy, imported goods become more expensive, and cutting rates becomes more difficult.

There is another important dynamic at work. Higher South African interest rates can help support the rand by attracting foreign capital. Put simply, investors are generally more willing to hold rands when they are being paid an attractive interest rate to do so.

The Reserve Bank can’t control the oil price, and it can’t determine what happens in Washington. But it can influence one side of South Africa’s imported inflation equation by helping maintain confidence in the currency.

That is one reason South African bond yields often move in the same direction as US Treasury yields

The bond market’s hidden influence

The bond market rarely enjoys the spotlight, yet bond yields affect government borrowing costs, corporate loans, mortgage rates, exchange rates, asset valuations and investment returns.

In many ways, they are the price of money itself, and when the price of money changes, everything else eventually adjusts.

The stock market may be the theatre of global finance, but the bond market is the plumbing behind the walls. It’s not particularly exciting until something breaks, and when it does, everyone notices.