Open Editor's Digest for free
Rula Khalaf, editor of the Financial Times, picks her favorite stories in this weekly newsletter.
When bond markets get volatile, it's no use being the ugliest horse in the glue factory. Unfortunately, this is the role the UK is now playing.
It's been a bleak start to the year for global bonds, but once again it contradicts what analysts and professional investors have told us to expect for 2025. From the United States to Japan, and almost everywhere in between, developed market governments and bond prices have fallen, pushing up yields and rising costs. Borrowing – a blow to countries that turn to investors in search of financing.
However, the UK has the unhappy distinction of suffering more than most other countries, and given the still-fresh memory of the 2022 government bond crisis, alarm bells are ringing. A strange new wrinkle in that tale arose this week, when the short-lived Prime Minister, Liz Truss, declared through her lawyer that it was unfair to suggest that she had caused the economy to collapse at the time. This is a strange move, and reflects a lack of familiarity with The Streisand effect.
In any case, the urgent question is whether we are at the beginning of a new phase gilts fire. The short answer, in my opinion, is no. The longer answer is that it is largely out of the hands of UK policymakers anyway.
To be clear, this week's gold bond tumble represents a dangerous episode. Not all, but many investors have been cool on UK debt for some time, spooked by persistent signs of inflation that will make it difficult for the Bank of England to continue cutting interest rates. Ten-year bond yields have risen by about half a percentage point since the new government's budget at the end of October. This is a fair bit of bond territory, representing a significant price decline and including some big declines on the opening days of this week to lift long-term yields to their highest levels since 1998.
Perhaps more worryingly, sterling took a hit, suggesting that this is not just a case of investors recalibrating their view on what the Bank of England will do next and when, but a risk-off move in the UK more broadly. (Even Gregg's stock price has fallen, and if you can't bet Brits will find the pennies to buy steaks and sausage rolls, something's really wrong.)
Declaring the bond shake-up a new crisis fits the political agenda of some observers. But context here is important. Overall, stocks have risen this early year so far, not fallen, reflecting the close relationship between the FTSE 100, crowded with offshore earnings, and the weaker pound. The same was not true in 2022, when the FTSE was smoked. Yes, a half-point increase in 10-year government bond yields is a significant increase since the Budget. But in 2022, it jumped by more than that in three days. The two things are not comparable. Sure, the pound has become weaker, but so has the euro, the yen, and everything other than a strong dollar.
That's the key here. The real story is the global rise in bond yields as the US economy continues to outpace other developed countries and inflation remains above target. In mid-December, The Federal Reserve noted The reduction in interest rates will not be as rapid as investors previously thought. A few weeks ago, markets reflected expectations that the Fed would move away from interest rates several times in the first months of this year. Now we're looking at cutting in the summer, maybe, and maybe another one later. Surprisingly strong US jobs data on Friday added further support here.
US bond yields, which exert a huge gravitational pull on the rest of the global debt markets, are also rising. Benchmark 10-year yields in the US have risen by about 0.2 percentage points so far this year, which is throwing the rest of the market out of control. The UK is in the crosshairs as weaker bonds put Chancellor Rachel Reeves in an awkward spot where she may have to cut spending or raise taxes. But revenues in fiscally strict Germany rose to a similar degree as those in the UK without causing much fanfare.
Beyond buoyant US economic performance, global pressures on bonds stem from what Nobel Prize-winning economist Paul Krugman described this week as “Premium madness“On bond yields in the United States.
“Increases in long-term interest rates, such as the 10-year Treasury rate, may reflect the dire and creeping suspicion that Donald Trump actually believes the crazy things he says about economic policy and will act on those beliefs,” Krugman wrote in his blog. High trade tariffs, tax cuts and potential mass deportations signal a renewed rise in inflation in the US.
So what stops rot? My feeling is that it stops itself. US bond prices will no longer fall once they begin to represent an irresistible bargain for investors. This is likely to happen if 10-year bond yields move closer to 5 percent, from about 4.8 now. The same may be true of the United Kingdom, which, for all its problems, is unlikely to default on its debt. Large round numbers, in this case five, have a strong tendency to convey this message.
But the embarrassing scenes on bond trading floors this week, for Reeves and for the rest of us, are a reminder that the United States is leading the way for developed markets. We are merely passengers and must hope to be guided carefully.
