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Bond guards could smell blood. Thanks to the shock in the UK government bond market, the living mayors of global finance are opening their coffins to warn that a crisis is coming, urgent action is needed, and soon a major debt reckoning will begin. Bonds are on the verge of a major price decline and heads should be rolling.
Exasperated voices tell us that UK Chancellor Rachel Reeves should resign, that she should have canceled her trip to China, and that the Bank of England should do something to deal with this sudden evaporation of investor confidence. This is all ridiculous. Bond market discipline is real. Just ask Liz Truss. The big risk is that investors will, at some point, become complacent about the huge volume of bonds they are being asked to absorb. They will refuse to continue buying or demand punitive interest rates, tying governments to decades of painful debt servicing costs.
This hinges on the idea that global government borrowing is out of control. There is a grain of truth in this. International Monetary Fund Calculated last year Global debt levels amount to about $100 trillion, which is a large number by all standards. “Countries must face debt risks now,” he said. Frankly, this means cutting spending severely 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 is not only British bond prices that are under pressure. Perhaps most worrying is that US yields have risen relentlessly in recent months even as the Federal Reserve has cut interest rates. This is very strange. Long-term bond yields generally decline when interest rates fall, Torsten Slok, chief economist at Apollo, noted this month.
This time, US 10-year bond yields have risen by about 1 percentage point since the Fed began cutting interest rates. “This is very unusual,” he wrote. “Is it financial 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 for investors to have a view on why long-term interest rates rise when the Fed cuts them.” .
Investors can cite a range of reasons for this, one of which is financial concerns. This may already be the beginning of a major pullback by money managers, and the great clash between governments and markets has already begun. But the truth may be more realistic.
Ian Steele, chief investment officer for international fixed income at JP Morgan Asset Management, is among those who are not convinced that this situation is as abnormal as it appears. He said that the rise in US bond yields since the start of interest rate cuts in September is “undoubtedly a big step.” But he also noted that yields had fallen a lot before the Fed's shift.
This presents a problem in itself – the usually staid government bond market has been prone to overreaction of late, which can lead to unpleasant setbacks. But the facts have changed too, as the Fed acknowledged in December. The economy is still doing well, and Donald Trump's economic policies still reek of inflation. Investors are busy writing down the interest rate cuts they have planned for 2025 and the market is moving accordingly.
For the UK, supposedly the main victim of the bond vigilantes' wrath, it remains very difficult to claim that anything meaningful has changed. “Can we really blame Rachel Reeves?” he asked Man Hedge Fund Group this week. “The current situation does not appear to be specific to the UK at all – with government bond and Treasury yields moving largely in tandem… Our lesson here is to be careful of what the media says.” (I'll take the liberty of excluding myself from this spoiler .)
Adding to this mix, the New Year's bond rush into the market has been unusually large. Investors say that was somewhat exaggerated last week when borrowers were keen to avoid a one-day US market closure on the occasion of the death of former President Jimmy Carter. The butterfly effect in action.
All of this has bond critics pushing the door open, especially in the UK. Hedge funds “looking to make a quick profit” appear to have played a big role in seeing how they can push government bonds to lower levels, Andrew Chorlton, chief investment officer for fixed income at M&G Investments, said at an event. Central banks also backed off their support for bond markets. The quantitative easing that accompanied ultra-low interest rates is over. With this safety net gone, what you see is the “real” price of government bonds.
It's easy now for those keen to attack bonds, or politicians. But bond market fluctuations are not created equal. I may be proven wrong, but this looks like a repricing, not a rebellion.
