Bond yields at crisis level as Australian government’s 10-Year Treasury rate passes 5 per cent

Australia has close to $1 trillion in gross debt and the cost of paying it off is soaring.

The blame rests largely on the Iran war.

It’s led to soaring oil prices with global benchmark Brent crude hitting multi-year highs over the past 24 hours.

This, in turn, has led to cost-push inflation as businesses pass on those higher costs to their customers.

The economic damage showed up in this week’s official inflation numbers, with annual inflation up to 4.6 per cent in March.

Treasurer Jim Chalmers also warned further inflation may be on the way.

“This war could drive inflation up even higher [than the latest ABS March monthly reading of 4.6 per cent] before it comes back down again,” Chalmers said.

It’s pushed the yield on 10-year Australian Commonwealth Treasury bonds well beyond 5 per cent.

This tells us global financial markets believe Australia has an inflation problem and is likely to see further RBA rate rises to try to contain it.

It could act as a wrecking ball through the May budget.

Government debt made simple

Firstly, though, here’s a brief explainer on the debt in question.

Australia has $962.6 billion in gross debt as of the end of April.

The Commonwealth issues Treasury bonds to raise money for everything from the NDIS to defence and health care.

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This is necessary when the budget is in deficit, or when expenses exceed revenue from taxes.

The government issues medium-term to long-term bonds.

An example of one of the debt securities is the Australian 10-year Commonwealth Government Security (CGS) or Treasury Note.

It’s an IOU. The government issues this security to central banks (including the RBA), commercial banks and superannuation funds.

The government usually raises the money via an online auction.

Is government debt really ‘risk-free’?

As the debt is put up for auction, its price moves.

If the securities are in hot demand, their prices will go up and their yields, or interest rates, will fall.

The opposite is also true.

In recent weeks, Australian government bonds have become less attractive to the market.

It’s pushed the yield, or interest rate, on a10-year government bond to close to 5.1 per cent.

The 10-year bond rate is considered the “risk-free” rate.

It’s a bit of market jargon to suggest the security itself is as safe as houses.

Hogan is pointing out that the global benchmark “risk-free” rate is the US 10-year Treasury bonds, which is currently yielding 4.43 per cent.

“We have broken away from the global anchor, the US Treasury interest rate, which remains closer to 4 per cent,” Hogan said.

Debt repayment tsunami

Back in December 2025, the mid-year economic and fiscal outlook (MYEFO) assumed an average funding rate for the government debt of 4.3 per cent.

Hogan says that will need to be revised up in the budget to something closer to 4.75 per cent.

“But if the market interest rate shifts up to 6 per cent, we will need billions more of taxpayers’ dollars each year,” he said.

And veteran budget watcher Chris Richardson warns something of a debt repayment tsunami is lapping at Australian shores should borrowing costs remain elevated.

“Although we borrowed lots during COVID, those borrowings were at super-cheap rates,” he said.

“But more and more of those COVID loans at bargain-basement rates will have to be refinanced at much higher rates over the next five years.”

Debt deficit spiral

Fiscal deficits can feed on themselves, too.

If government debt continues to soar, along with repayments, and the slower growth of an inflation shock rips through the jobs market, the federal government could find itself in a most awkward fiscal position.

“For the government, this means higher borrowing costs, making any fiscal support that may be required in slower growth environments more expensive to fund,” Jamieson Coote Bonds’s Charlie Jamieson said.

The nasty downward spiral is higher-for-longer deficits and debt with lower economic growth.

“It’s also raising the question, in institutional circles, as to the future ‘cost of capital’ assumptions, which drive private and illiquid market discount rate valuations,” Jamieson said.

In other words, if relatively safe debt like a government bond is deemed riskier, it throws out the assumptions of how thousands of other assets and securities are priced.

In simple terms, borrowing becomes more expensive and asset prices fall.

On the flip side, economists argue that a higher inflationary environment brings about budget bracket creep, which could improve the budget bottom line.

That is, the increase in the per-unit cost of labour can push wage earners into higher tax brackets, which may raise further income tax revenue for the government.

Or put another way, the value of money also falls in an inflationary environment, reducing the nominal value of the debt.

For example, the $1 trillion in debt becomes relatively easier to pay if the government’s tax take increases in nominal terms as wages rise.

Economists sometimes refer to the idea of inflating away debt — where high inflation reduces the real value of fixed-interest debt.

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RBA inflation message is crucial

For households, it points to more pain in the near term, especially for mortgage borrowers.

“It’s telling me that the bond market is expecting higher inflation and more RBA rate hikes, leaving rates higher for longer,” AMP’s chief economist, Shane Oliver, said.

The Reserve Bank decides on interest rates next Tuesday.

The expectation is that the RBA will lift the cash rate to 4.35 per cent.

But, clearly, the RBA’s communications team will also need to deliver the message that Australia does not have an “inflation problem” or, at the very least, that the central bank will do what it takes to return inflation to the target of 2.5 per cent.

Presently, global financial institutions aren’t buying the message that Australian inflation is under control, and it’s a large burden on the budget and millions of households.