Why the bond market is flexing its muscles, and why everyone needs to care

The bond market is one of the few forces in the world strong enough to get politicians to snap to attention

NEW YORK -- The bond market is one of the few forces in the world strong enough to get politicians to snap to attention. It also helps dictate how much ordinary people have to pay on their mortgages and car loans, as well as how much they earn from their savings accounts and 401(k) plans .

This week rising bond yields forced the U.S. Treasury Department into an unusual intervention and raised the specter of higher borrowing costs putting the brakes on consumer spending , the lifeblood of the economy . It also sparked concerns that investors might finally be thinking twice about financing a seemingly endless flow of government borrowing .

When governments and big companies borrow money, they don't ask a bank for a loan. Instead, they sell IOUs to investors and promise to repay the money with a certain interest rate. If those IOUs are set to be repaid many years from now, they're called bonds. (IOUs the U.S. government will repay more quickly are more often called bills or notes.)

Investors in the bond market often buy and sell these bonds after they're issued, and they continue to pay the same interest rate. But if the bond starts to look less attractive, a buyer can get bonds that were earlier worth $100 for less than that. Such a drop in price means the new buyer will get a bigger return, percentage-wise, on their money than the interest rate the bond pays on its face value. Those payments are called the bond's yield.

The world's biggest and most important bond market is for IOUs from the U.S. government, which are called Treasurys. The total size of it was $31.5 trillion, as of July, according to the Securities Industry and Financial Markets Association.

Yet Treasurys are facing more competition from higher-yielding bonds overseas than in recent decades. After years of near-zero interest rates, even 30-year Japanese government bonds are now paying more than 4%. Yields on U.K. bonds have reached 5.81%, and German bonds are also paying 3.76%, versus 5.27% for a comparable U.S. bond. It's a big reason U.S. rates have been drifting higher.

Ira Jersey, chief U.S. interest rate strategist at Bloomberg Intelligence, said that large global investors such as pension funds and life insurers used to have little choice to invest in Treasurys because most other overseas bonds paid so little interest.

“Now the U.S. 30-year yield has to compete with all these other sovereign bonds,” Jersey said. “The U.S. is not the only game in town anymore.”

The easiest example is mortgage rates. Rates for these loan tend to follow the path of yields for Treasurys that will get repaid in 10 years.

The 10-year Treasury yield is the centerpiece of the bond market, and it shot higher through the summer after the war with Iran sent oil prices higher and worries about inflation upward, adding to longstanding concerns about the size of the U.S. government's debt.

That in turn made mortgages more expensive for people looking to buy a house.