Bond markets have entered a new era of antagonism with governments, fund managers say, as investors sell sovereign debt in major economies such as the UK, France and the US amid a deluge of borrowing.
Heavy UK government borrowing in October triggered a sell-off in the gilt market, pushing the 10-year yield to the highest level since 2008 and 30-year interest rates cost the most in this century.
The political crisis in France has pushed borrowing costs above those in Greece, as it struggles to pass an austerity budget. In the US, the government bond market has been hit by concerns that President-elect Donald Trump will borrow freely and cut taxes.
These moves are driven by investors in government bonds, who once again assume the role of fiscal discipline enforcers, demanding higher yields when the state of government finances deteriorates.
“There is a resurgence of activism in the bond market,” said Robert Dishner, senior portfolio manager at Neuberger Berman.
“The markets are not used to this as it usually happens in the corporate space,” he said, adding that the pressure had “passed on” to sovereign states.
High borrowing through the Covid pandemic has helped to significantly increase debt burdens in major economies such as the UK, France and the US. Net government debt will exceed 100 percent of GDP this year in the USA and France, and according to IMF forecasts, it will be close to that level in Great Britain.
Annual deficits have widened and will exceed 7 percent of US GDP in 2025, analysts say. The French government is targeting a deficit of 5-5.5 percent of GDP for 2025.
In the UK, the Labor government’s decision in October to loosen policy compared to previous plans added to investor unease. According to official forecasts, public borrowing in the current fiscal year will amount to 4.5 percent of GDP, and will fall to 3.6 percent next year.
The extra yield required by UK debt investors compared to German 10-year bonds rose above 2.3 percentage points last month, the biggest premium since 1990 and even above the level reached after former Prime Minister Liz Truss’s ill-fated “mini” Budget 2022.
France expands with Germany resurrected to the highest level since the debt crisis in the eurozone, reaching 0.9 percentage points in November. Yields on ten-year US government bonds jumped from 3.6 percent in September to nearly 4.7 percent.
The moves came even as central banks began to cut interest rates — typically the main driver of bond yields — as the post-pandemic surge in inflation faded. Sales were concentrated on longer-term debts, which are most sensitive to the volume of issuance.
“I like to think the government bond market has grown up,” said April LaRusse, head of investment specialists at Insight Investment.
Bond investors tend to create a “low rumble in the background” of policymaking, but events in the UK and France showed they were starting to ramp up the pressure, LaRusse added. “They will tell the governments [when] they push things too far.”
The sell-off has drawn comparisons with so-called “bond watchers” — a group of investors who fueled changes in US fiscal policy in the 1990s by pushing yields higher, but which have recently been dormant. Although tensions are not at those levels, fund managers say there has been a marked departure from the era of low rates and quantitative easing after the global financial crisis, when central bank buying was the dominant force in bond markets.
“Very high levels of debt” in countries such as the United Kingdom and France have prompted investors to resume their former role as “police to drive responsible fiscal policy,” said Peder Beck-Friis, an economist at Pimco, which manages $2 trillion.
“You don’t need big shocks to fiscal policy or political news to create a pretty big one [lot of] volatility” in the markets, he added.
As China sells some of its foreign debt and central banks shrink their balance sheets, “we no longer have a price-insensitive buyer” of bonds, said Niall O’Sullivan, director of global investment solutions at Mercer. “[Bond markets] as a result they are more in control,” he added.
A number of governments are borrowing heavily to try to stimulate growth and are failing to reassure markets with their plans to rein in fiscal deficits.
Bank for International Settlements warned in December that rising debt levels were “one of the biggest threats, if not the biggest threat going forward to the global economy”, and higher borrowing costs were a sign that markets were realizing they would have to absorb more debt.
In the UK, investors have warned that higher borrowing costs make it increasingly likely that Chancellor Rachel Reeves will breach her new fiscal rules when official forecasts are released in March. And Moody’s downgraded France’s credit rating in December, warning of “negative feedback loops between higher deficits, higher debt and higher funding costs.”
Bondholder activism is even starting to make its mark on the $26 trillion US Treasury bond market, where the dollar’s status as the global reserve currency means that many investors around the world have no choice but to buy government bonds.
Pimco he said last month it cut exposure to long-term U.S. debt due to concerns about sustainability, adding that bond caution will gradually be felt.
“There is no organized group of vigilantes ready to act on a certain debt threshold; changes in investor behavior tend to happen across the board and over time,” the asset manager said.
But Trump’s promises to cut taxes could prompt such a shift, if he fully delivers on them, some investors say.
“If the Republicans try to throw in everything that was discussed during the campaign without paying for most of it, that would really raise the specter of a bond rebound to me,” said Sonal Desai, CIO of fixed income at asset manager Franklin Templeton. .
