Bond vigilantes can smell blood. In the wake of the turmoil in the UK government bond market, the undead sergeants of global finance are opening coffins, warning that a crisis is coming, urgent action is needed and a massive debt settlement will soon begin. Bonds are on the verge of a sharp price drop, and heads must be clear.
Excited voices tell us that Chancellor of the Exchequer Rachel Reeves should resign, that she should cancel her trip to China, and that the Bank of England should take steps to counter the sudden loss of investor confidence. This is all stupid. Bond market discipline is real. Just ask Liz Truss. The biggest risk is that at some point, investors will become sick of the large number of bonds they are being asked to digest. They either refuse to continue buying or demand punitive interest rates that would saddle the government with decades of painful debt-servicing costs.
This hinges on the perception that global government borrowing has spiraled out of control. There is some truth to this. The International Monetary Fund calculated last year that global debt levels were about $100 trillion - a large number by any standard. "Countries should face debt risks now," it said. Frankly, that means cutting spending aggressively or relying on inflation to reduce debt. Option one is not without cost. The second option is keeping bond investors awake at night.
Of course, it's not just UK bond prices that are under pressure. Perhaps more worryingly, U.S. Treasury yields have continued to move higher in recent months despite significant interest rate cuts by the Federal Reserve. This is very strange. As Apollo chief economist Thorston Slock noted this month, long-term bond yields typically fall when interest rates fall.
This time, the U.S. 10-year Treasury yield is up about a percentage point since the Fed began cutting interest rates. "This is highly unusual," he wrote. "Are they fiscal concerns? Is there less demand from abroad? Or maybe the Fed's rate cuts are unjustified? The market is telling us something, and it's important for investors to understand why long-term rates rise when the Fed cuts rates. of."
Investors can cite a range of reasons for this, one of which is financial concerns. Perhaps this is indeed the beginning of a strong pushback by fund managers, and a huge conflict between government and markets has begun. However, the truth may be much more prosaic.
Iain Stealey, chief investment officer for fixed income international at JPMorgan Asset Management, isn't convinced the situation is as abnormal as it seems. He said the move higher in U.S. Treasury yields since the rate cuts began in September was "definitely a big move." But he also noted that yields had already fallen significantly before the Fed pivoted.
This is a problem in itself - the normally stable government bond market has been prone to overreaction of late, which could lead to an unpleasant rally. But as the Fed acknowledged in December, the facts have changed. The economy is still doing well, and Donald Trump's economic policies smack of inflation. Investors are busy writing down how much of a rate cut they expect in 2025, and markets are moving accordingly.
For Britain, considered the main victim of the wrath of bond vigilantes, it remains hard to argue that any meaningful change has occurred. "Can we really blame Rachel Reeves?" hedge fund group Man asked this week. “The current situation does not appear to be unique to the UK at all – gilts and gilt yields have largely moved in tandem . (other than burns).
On top of that, the influx of New Year bonds into the market is unusually large. Investors said that was overblown last week as borrowers rushed to avoid a day-long shutdown in U.S. markets following the death of former President Jimmy Carter. The butterfly effect in action.
All this leaves the door wide open for bond bashers, especially in the UK. Andrew Chorlton, chief investment officer for fixed income at M&G Investments, told an event that hedge funds "looking for a quick buck" appeared to have played a major role in pushing gilts to as low as low levels. Central banks have also withdrawn support for bond markets. Quantitative easing, which accompanied ultra-low interest rates, has ended. With the safety net gone, the prices you see on government bonds are more "real".
It's easy now for those who enjoy bashing bonds or politicians. But bond market volatility is not created equal. I may be proven wrong, but this feels like repricing, not rebellion.
katie.martin@ft.com