Australia faces higher public debt costs after new peak

By Derek Rose

The federal government faces higher long-term costs to finance its massive public debt, a development with far-reaching implications for taxpayers, corporations and share markets.

The danger comes after the yield on Australia’s 10-year government bonds rose beyond 5.4 per cent this week to the highest level since mid-2011.

At the same time, the average 10-year government yield for the world’s seven biggest economies hit its highest level since the global financial crisis in mid-2008.

Yields, which represent the annual return investors receive by lending money, had pulled back slightly by Friday but were still historically high.

“It doesn’t look like a US-specific story, or an Australian-specific story, or a UK-specific story,” according to Moomoo chief market strategist Tapas Strickland.

“It seems like there’s a secular rise in bond yields.

“Markets are effectively equilibrating to a higher interest rate environment because potential growth rates are lifting and because governments around the world have very large budget deficits.”

Artificial intelligence hyperscalers – which include mammoth companies like Meta, Alphabet and Microsoft – have also been borrowing dramatically to build data centres to support the technology.

“The AI build-out is about $800 billion this year and set to rise to $1.2 trillion next year,” Mr Strickland tells AAP.

High levels of public debt in countries like the US, France, the UK and Japan are driving the rise in bond yields, as well as borrowing by big tech companies, AMP chief economist Shane Oliver notes.

“US corporates, or corporates generally, have been borrowing dramatically to build their AI data centres, so that competes with other borrowing,” he says.

Alphabet in August tapped Australian institutional investors for $A5.5 billion – the largest corporate bond issue in Australian history – as part of its fundraising for its data centre rollout, which it expects to spend around $US200 billion ($280 billion) on in 2026.

All that competition for funds pushes up yields, making long-term borrowing more expensive.

Australia’s Office of Financial Management on Wednesday sold $1 billion in bonds maturing in April 2037 at an interest rate of 5.391 per cent.

That’s up significantly from the 4.974 per cent it agreed to at a similar tender in August.

The federal government expects to issue $125 billion in bonds in 2026/27, so the increase in yields will increase its borrowing costs by billions of dollars.

“It’s going to mean higher debt servicing costs for the federal government,” Dr Oliver says.

Australia already has more than a trillion dollars worth of government debt on issue.

David Bassanese, chief economist at Betashares, says rising bond yields also reflect rising inflationary pressures stemming from the war in the Middle East.

Higher inflation means people’s money is worth less over time, so investors want a higher premium for holding bonds, he explains.

But despite concerns about the US government’s huge debt pile – which has surpassed $US40 trillion ($56 trillion) for the first time – the rise in bond yields doesn’t seem to reflect concerns the US might default.

“Generally, when there’s fiscal solvency concerns, it’s a term premium that actually starts to rise,” Mr Strickland says, referring to the extra premium investors want for holding long-term debt.

“What we’ve seen in the US is that term premium is not rising at all – it’s actually been flat and that’s quite surprising given all the rhetoric around debt and deficit.”

High bond yields also tend to put pressure on equity markets.

“The incentive to put your money in the share market goes down because you get more money from the so-called risk-free asset like bonds,” Dr Oliver says.

While share markets have adjusted to the rise in bond yields, there’s still risk they will continue to rise.

“A five per cent yield market would be okay,” Mr Bassanese says.

“Five and a half, six per cent probably less so.”

Next week, the Reserve Bank of Australia is expected to increase interest rates following a board monetary policy meeting that concluded on September 29.

It’s a move that will undoubtedly flow through to consumers and business.