More than 9% of all American mortgage borrowers fell into arrears in the first three months of this year, it emerged today, as a sell-off of government bonds raised fears that higher borrowing costs for families and businesses could strangle a fragile economic recovery.
Investors on both sides of the Atlantic have been dumping bonds as they bet on economic recovery, driving up the yield, or interest rate, on government debts. In the UK, investors saw the yield on the 10-year gilt rise to 3.8% today. Many interest rates across the economy are set with reference to bond yields.
The quarterly National Delinquency Survey revealed that with US house prices down by 30% from their peak, the share of homeowners who have fallen behind with their payments is still rising rapidly.
Despite desperate efforts by Barack Obama's administration to reduce the number of people losing their homes, the report also showed that the rate of repossessions is rising, with more than one in 100 borrowers falling into the foreclosure process in the first three months of 2009.
News of the continued deterioration in the US housing market came amid growing fears that rising interest rates could choke off an upturn. A frenzied sell-off in US government bond markets in the past few days has pushed up the yield on the benchmark 10-year treasury – in effect, the interest rate investors are charging the government to borrow – to a six-month high of 3.7%."It's been a dramatic rise in yields," said John Wraith, gilt strategist at RBC Capital Markets.
Like the Bank of England, the US Federal Reserve has embarked on "quantitative easing" – buying back government bonds from investors to drive down borrowing costs and reduce interest rates across the bombed-out US economy.
But as hopes of imminent recovery from recession have risen, driving a powerful rally on stockmarkets, bond investors have begun to fret about the hefty debts the government has taken on and bet interest rates will soon rise as the Fed responds to the rosier outlook.
Alan Ruskin, of RBS, said the Fed chairman, Ben Bernanke, and his colleagues could face a dilemma in coming weeks as they try to drive interest rates down but the market pushes against them.
"The fight for control over long-term yields is set to become epic, leaving the Fed with a tough tactical choice. It could increase its [quantitative easing] purchases on a similar scale to what has been seen and risk being pushed aside, or increase its purchases to the point where they dominate the market, only to risk investors viewing this as seriously inflationary."
In the UK, rising yields are echoing the US move. Wraith said that although the Bank of England's programme of bond buybacks is proportionately much larger than the Fed's, once recovery is under way in the UK the market will start dumping government debt, driving up the cost of borrowing for the Treasury.
"There's a bit of a lesson from what's going on in the US," he said. "It's masked here by the Bank of England going full steam ahead, but quantitative easing has to stop some time."
Fresh evidence of the headwinds facing Britain's economy came in the CBI's monthly survey of the high street, which suggested credit-crunched shoppers have gone back to belt-tightening. The CBI said 31% of retailers reported rising sales in May against a year earlier, while 48% reported falls, resulting in a net balance of -17%. It follows a positive balance of +3% in April, which some analysts hoped had marked the beginning of a retail recovery. The CBI said the pace of decline in high-street sales has slowed from the 40-50% negative balances seen in January.
"Retailers are less pessimistic about their general situation, and the decline in demand now appears to be slowing. However, with unemployment still rising, conditions will remain tough," said Ian McCafferty, the CBI's chief economist.
