End to record cheap mortgages in sight

A sudden surge in Government bond yields could signal the end of low-rate home loans.

The price of government bonds around the world has suddenly slumped over the past five weeks.

As a result, the yields (yearly interest rates) paid by UK Government bonds have surged to two-year highs. And that could spell bad news for mortgage interest rates.

'Taper terror' rocks markets

For the past several years, quantitative easing by the US Federal Reserve and Bank of England has created a one-way return for traders. Investment banks and the like borrow vast sums very cheaply from central banks and then invest them in higher-yielding assets, such as corporate bonds and emerging-market debt.

This enables traders to make handsome returns with little risk, thanks to the supreme generosity of central banks. However, the end of this one-way trade is now in sight, thanks to comments last week by Ben Bernanke, chairman of the US Federal Reserve.

Bernanke warned that the Federal Reserve would begin to taper its current programme of quantitative easing, known as QE3. In this open-ended programme since December 2012, the Fed has committed to buying $85 billion of Treasury and mortgage bonds each month.

Bernanke has now warned the markets that the Fed is minded to start 'tapering' its bond purchases as the US economy strengthens. This tapering is likely to begin later this year and QE3 could cease by mid-2014.

Fearful of lower bond prices, traders have been dumping massive amounts of bonds. As a result of this wave of selling, bond yields have soared around the world -- including those of gilts (UK Government bonds).

Bad news for the Government

Around five weeks ago, the yield for the ten-year gilt hit an all-time low of 1.5% a year. On Monday, it moved above 2.5% before dropping back slightly. This means that this benchmark yield has risen by a whole percentage point -- a rise of two thirds -- in little over a month.

I struggle to recall a spike of such magnitude going back almost 20 years. In short, the past few weeks have been an absolute bloodbath for gilts.

This steep surge in gilt yields from their record lows is worrying news for George Osborne, the Chancellor of the Exchequer. With the Government borrowing around £10 billion a month by issuing gilts, higher yields will mean bigger interest payments and, therefore, more pressure on future public spending.

Future shock

Predicting the future is always a dangerous game, but when markets turn, they often harm the largest number of participants. After a bull market in bonds lasting over 30 years, the future looks to be highly volatile and uncertain.

Clearly, such a sudden and disruptive move in bond yields is a bad thing for bondholders, who have been hit with losses exceeding $1 trillion in the past month alone. That said, the wider worry is that raised bond yields could eventually feed through into higher interest rates across the board, both for companies and individuals. While this would be great news for savers, it would be terrible for British borrowers, especially given that the UK's combined private and public debt is at an all-time high.

Although there is no direct mechanism joining UK bond yields to general interest rates, gilts do not exist in a vacuum. As yields rise, gilts become relatively more attractive in comparison to other assets, such as mortgage bonds, shares and real estate. As a result, higher gilt yields could trigger a general rise in interest rates that pushes up borrowing costs for everyone.

What's more, higher gilt yields may discourage banks from lending to homebuyers and businesses. Why take a risk lending to a homebuyer at, say, a fixed rate of 2% a year when you can bank the 'risk free' returns of buying gilts and collecting a coupon of 2.5% a year?

US mortgage rates leap by 1%

There have been early warning signs from America.

In the USA, average mortgage rates have surged by a full percentage point in less than a fortnight, pushing up future interest bills and the cost of servicing home loans. Were this pattern to be repeated in the UK, it could add billions of pounds a year to the interest paid by those among the UK's 11.3 million mortgage borrowers without fixed-rate loans.

This sudden leap in gilt yields is a warning shot, both for bondholders and for heavily indebted individuals and companies. When the Federal Reserve finally stops administering the monthly medicine and bond markets go cold turkey, the impact of the bursting of the bond bubble could be stunning and long-lasting.

While this era of cheap money fuelled by central banks is likely to last another year at least, markets have already begun pricing in higher interest rates to come. So if you're looking for a cheaper home loan, then it may be wise to act now while stocks last. In a year's time, mortgage rates will surely be above this year's lifetime lows!

What do you think? Are you more likely to move mortgage now? Or do you think the Funding for Lending Scheme will keep mortgage rates low for a while? Let us know your thoughts in the comment box below.

This article aims to give information, not advice. Always do your own research and/or seek out advice from a regulated broker (such as one of our brokers here at Lovemoney.com), before acting on anything contained in this article.

Your home or property may be repossessed if you do not keep up repayments on your mortgage.

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