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Bond vigilantes can smell blood. Revived by the UK government bond market quake, the undead sheriffs of global finance are opening their coffins to warn that a crisis is coming, that urgent action is needed and that the great debt showdown is about to begin. Bonds are on the verge of a sharp price drop and heads must roll.
Excited voices are telling us that British Chancellor Rachel Reeves should resign, that she should cancel her trip to China, that the Bank of England should do something to deal with this sudden evaporation of investor confidence. This is all stupid. Bond market discipline is real. Just ask Liz Truss. There is a big risk that investors will at some point become suffocated by the huge amount of bonds they are asked to digest. They will either refuse to continue purchases or demand punitive rates, binding governments to decades of painful debt servicing costs.
It depends on the idea that global government borrowing is out of control. There is a grain of truth in this. of the IMF calculated last year that global debt levels are around $100 trillion—a large number by any measure. “Countries should now face debt risks,” it said. Frankly, this means cutting spending hard or relying on inflation to reduce debt. The first option is not without costs. The second option is what keeps bond investors up at night.
Of course, it’s not just British bond prices under pressure. Perhaps more alarmingly, US yields have risen relentlessly in recent months even as the Federal Reserve has cut interest rates. This is extremely strange. Yields on long-term bonds generally fall when interest rates fall, as Apollo chief economist Torsten Slok pointed out this month.
This time, US 10-year yields are up about a percentage point since the Fed started cutting. “This is very unusual,” he wrote. “Are they fiscal concerns? Is there less demand from abroad? Or maybe the Fed’s cuts were not justified? The market is telling us something, and it’s very important that investors have insight into why long-term rates are rising while the Fed is tapering.”
Investors can cite a number of reasons for this, one of which is fiscal concerns. Perhaps this is indeed the beginning of a major backlash from money managers and a major conflict between governments and markets has already begun. The truth, however, is probably much more prosaic.
Iain Stealey, international chief investment officer for fixed income at JPMorgan Asset Management, is one of those who is not convinced that this situation is as abnormal as it seems. The rise in U.S. yields since the start of rate cuts in September is “a big move, no doubt about it,” he said. But he also noted that yields fell well before the Fed’s pivot.
That’s problematic in itself – the typically quiet government bond market has been prone to overreaction lately, which can lead to nasty price pullbacks. But also, the facts have changed, as the Fed acknowledged in December. The economy is still doing well, and Donald Trump’s economic policies smack of inflation. Investors are busily scribbling down the rate cuts they have planned for 2025 and the market is moving accordingly.
For the UK, supposedly the main victim of ratepayers’ anger, it remains very difficult to argue that anything significant has changed. “Can we really blame Rachel Reeves?” asked hedge fund group Man this week. “The current episode does not appear to be UK specific at all — gilt and Treasury yields are moving largely in tandem. . . Our lesson here is to watch what the media says.” (I’ll take the liberty of opting out of that burn.)
In addition, the New Year rush of bonds that appeared on the market was unusually large. Investors say that was somewhat exaggerated last week when borrowers sought to avoid a one-day shutdown of the U.S. market on the death of former President Jimmy Carter. The butterfly effect in action.
All this has left the door wide open for bond raiders, particularly in the UK. M&G Investments’ Andrew Chorlton, chief investment officer for fixed income, told an event that hedge funds “looking to make a quick buck” played a big role in seeing how low they could push gilts. Central banks have also withdrawn their support for bond markets. The quantitative easing that accompanied super-low interest rates is over. With that safety net gone, what you see is more of a “true” price for government bonds.
It’s easy for those who want to attack bonds or politicians, right now. But bond market fluctuations are not equal. I may be wrong, but this seems like re-pricing, not rebellion.
