Fund managers say the bond market has entered a new era of conflict with governments, with investors selling sovereign debt amid a borrowing rush in major economies such as Britain, France and the United States.
Britain’s huge borrowing budget in October triggered a sell-off in the gold market, pushing 10-year bond yields to their highest level since 2008 and 30-year interest costs to their highest in this century.
A political crisis has left France with borrowing costs higher than Greece as it struggles to pass an austerity budget. In the United States, the government bond market has been hit by concerns that President-elect Donald Trump will borrow freely and cut taxes.
Government bond investors are driving this movement, once again playing the role of enforcer of fiscal discipline by demanding higher yields when government finances deteriorate.
“We’re seeing a resurgence of activity in the bond market,” said Robert Dischner, senior portfolio manager at Neuberger Berman.
“The market is not used to this, as it usually happens in the corporate sector,” he said, adding that the pressure had “shifted” to indebted governments.
Debt burdens have soared in large economies such as the UK, France and the US due to heavy borrowing due to the coronavirus pandemic. The IMF predicts that net government debt will exceed 100% of GDP in the US and France this year, and will approach that level in the UK.
Analysts say the deficit is widening every year and is expected to exceed 7% of U.S. GDP by 2025. The French government has set a target of reducing the budget deficit to 5-5.5% of gross domestic product (GDP) in 2025.
In the UK, the Labor government’s decision to ease policy in October compared to previous plans increased investor anxiety. According to official forecasts, public borrowing will be 4.5% of GDP this fiscal year, falling to 3.6% next year.
The extra yield investors demand on UK government bonds compared to German 10-year bonds exceeded 2.3 percentage points last month, the biggest premium since 1990 and ex-chancellor Liz Truss’ ill-fated 2022 “mini” It even exceeded the level reached after the Budget.
The spread between France and Germany rose to its highest since the euro zone debt crisis, reaching 0.9 percentage points in November. The yield on the 10-year U.S. Treasury rose to nearly 4.7% from 3.6% in September.
The moves come even as post-pandemic inflation has slowed and central banks have begun lowering interest rates, which are typically the main driver of bond yields. Selling has been concentrated in long-term bonds, which are most sensitive to issue size.
“I like to think of the government bond market as the adult in the room,” said April Larousse, head of investment specialists at Insight Investment.
Fixed income investors are usually a “low voice in the background” of policy decisions, but events in the UK and France show how pressure is starting to mount, Larousse added. “They are going to tell the government [when] They take things too far. ”
This steep decline has led to comparisons with so-called “bond vigilantes.” The group is a group of investors who pushed for changes in U.S. fiscal policy in the 1990s by forcing yields to rise, but has recently become dormant. Although tensions are not at that level, fund managers say there has been a decisive shift since the post-GFC era of low interest rates and quantitative easing, when bond markets were dominated by central bank buying. It says that there are.
With “so high debt levels” in countries such as the UK and France, investors are resuming their former role as “responsible fiscal policy police” with $2 trillion under management. said Peder Beck-Fries, an economist at fund firm Pimco. .
“Fiscal policy and political news don’t need to be hugely shocking to have a big impact. [lot of] Market volatility,” he added.
Niall O’Sullivan, Mercer’s chief investment officer for global solutions, said there is “no longer a price-sensitive buyer” for bonds as China sells some of its external debt and its central bank shrinks its balance sheet. said. “[Bond markets] As a result, it has become a more dominant force, he added.
Many governments are borrowing heavily to boost growth, but have failed to reassure markets with plans to rein in budget deficits.
The Bank for International Settlements said in December that rising debt levels are “one of the greatest threats, if not the greatest threat, to the global economy going forward” and that rising borrowing costs will require markets to absorb more debt. He warned that this was a sign that he was aware of what was not going to happen. .
In Britain, investors have warned that rising borrowing costs are raising the possibility that Chancellor of the Exchequer Rachel Reeves will breach new fiscal rules when she releases her official outlook in March. And Moody’s downgraded France’s credit rating in December, warning of a “negative feedback loop between rising deficits, rising debt burdens and rising financing costs.”
The aggressive activities of bondholders are beginning to have an impact on the $26 trillion U.S. government bond market, and the dollar’s status as the world’s reserve currency means that many investors around the world have no choice but to buy U.S. Treasuries. This means there are few options.
Pimco said last month it was cutting its exposure to long-term U.S. Treasuries, citing sustainability concerns, adding that the bond wariness would be felt gradually.
“There is no organized vigilante group poised to act when a certain debt threshold is reached. Changes in investor behavior typically occur over time and with time to spare.” the company stated.
But some investors say Trump’s tax cut promise, if fully implemented, could prompt such a shift.
“If Republicans were to go all in without paying for most of what was discussed during the campaign, it would be a big deal to me,” said Sonal Desai, chief investment officer for fixed income at asset management firm Franklin Templeton. “There will be great concern that bond vigilantes will return.” .
