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When bond markets get sticky, it’s useless to be the ugliest horse in the glue factory. Unfortunately, that is the role that the UK now plays.
It’s been a dismal start to the year for global bonds, again contrary to what astute analysts and professional investors have told us to expect for 2025. From the US to Japan, and almost everywhere in between, developed market government bond prices have fallen, pushing up yields and borrowing costs – a blow to countries reaching out to investors in search of financing.
The UK, however, has the unfortunate distinction of suffering more than most, and with the 2022 gilt crisis still a recent memory, alarm bells are ringing. An interesting new wrinkle appeared in that story this week, when the prime minister of that mercifully brief period, Liz Truss, said through her lawyers that it was unfair to suggest that she crashed the economy at the time. This is a strange move that reflects poor familiarity The Streisand Effect.
In any case, the burning question is whether we are at the beginning of something new gilts stake. The short answer, in my opinion, is no. The longer answer is: it’s largely out of the hands of UK policymakers anyway.
To be clear, this week’s gilt drop is a serious episode. Not all, but many investors have been cold on British debt for some time, spooked by signs of persistent inflation that will make it harder for the Bank of England to continue cutting interest rates. Ten-year yields have risen by about half a percentage point since the new government’s budget at the end of October. That’s quite a chunk in bond land, which represents a big drop in prices and includes some significant declines in the early days of this week to push long-term yields to their highest since 1998.
Perhaps more alarmingly, sterling also took a hit, suggesting this is not just a case of investors recalibrating their views on what the BoE will do next and when, but a flight from UK risk more broadly. (Even the share price of Gregg’s has fallen, and if you can’t bet that Brits will find a dime to grill steaks and sausage rolls, something is seriously wrong.)
Declaring the gilt shake-out a new crisis fits the political agenda of some observers. But context is important here. Overall, shares have risen rather than fallen so far this young year, reflecting the tight link between the FTSE 100 index, loaded with overseas earnings, and the weaker pound. The same was not true in 2022, when the FTSE went up in smoke. Yes, a half-point increase in 10-year gilt yields is a lot more than budgeted. But in 2022, they jumped even more in three days. Those two things are simply not comparable. And the pound is weaker, of course, but so are the euro, yen and everything else except the mighty dollar.
That’s the key here. The real story is the global rise in bond yields as the US economy continues to outperform other developed countries and inflation remains above target. In mid-December, Federal Reserve Indicated it would not be as quick to cut rates as investors previously thought. A few weeks ago, markets reflected expectations that the Fed would cut interest rates several times in the first months of this year. Now we’re looking at the summer, probably, and maybe another one later. A surprisingly strong US jobs report on Friday added even more fuel.
US bond yields, which exert a huge gravitational pull on the rest of global debt markets, are also rising. U.S. 10-year benchmark yields are up nearly 0.2 percentage points so far this year, and that’s blowing out the rest of the market. The UK is in the crosshairs as weaker players box Chancellor Rachel Reeves into the awkward position of having to cut spending or raise taxes. But yields in fiscally tight Germany rose by a similar rate to those in the UK without much fanfare.
Beyond the successful U.S. economic performance, global pressure on bonds stems from what Nobel Prize-winning economist Paul Krugman described this week as “insanity premium” on US bond yields.
“A rise in long-term rates, like the 10-year Treasury rate, could reflect a nagging, creeping suspicion that Donald Trump actually believes the crazy things he says about economic policy and will act on those beliefs,” Krugman wrote on his blog, a reference to high trade tariffs, tax cuts and potential mass deportations that point to a resurgence of US inflation.
So what stops the rot? I have a feeling it’s stopping by itself. US bonds will no longer slide in price once they begin to present an irresistible offer to investors. That is likely to be if and when 10-year yields approach 5 percent, from nearly 4.8 now. The same probably applies to the UK, which, for all its problems, is highly unlikely to default on its debt. Big round numbers, in this case five, have a strong tendency to hammer that message home.
But the awkward scenes on bond trading floors this week are, for Reeves and the rest of us, a reminder that the US drives a developed-market car. We are just passengers and we hope they will drive carefully.
