Bond markets have entered a new era of antagonism with governments, fund managers say, as investors sell sovereign debt in big economies such as the UK, France and the US amid a deluge of borrowing.
The UK’s heavy-borrowing budget in October has triggered sell-offs in the gilt market, pushing the 10-year yield to its highest level since 2008 and 30-year interest costs to the most this century.
France’s political crisis has driven its borrowing costs above those of Greece, as it struggles to pass a budget of belt-tightening measures. In the US, the Treasury market has been hit by concerns that president-elect Donald Trump will borrow freely and cut taxes.
Driving these moves are government bond investors who are once again taking up the role of enforcers of fiscal discipline, by demanding higher yields when government finances deteriorate.
“There is a revival of bond market activism,” said Robert Dishner, senior portfolio manager at Neuberger Berman.
“The markets aren’t used to this as it usually happens in the corporate space,” he said, adding that pressure had “transferred” to indebted sovereigns.
High borrowing through the Covid pandemic has helped push debt burdens sharply higher in big economies such as the UK, France and the US. Net government debt will exceed 100 per cent of GDP in the US and France this year, and will be close to that level in the UK, according to IMF forecasts.
Yearly deficits have widened and are set to exceed 7 per cent of GDP in US in 2025, analysts say. The French government is targeting a deficit of 5-5.5 per cent of GDP for 2025.
In the UK, the Labour government’s decision in October to loosen policy compared with prior plans added to investor unease. Public borrowing will be 4.5 per cent of GDP in the current fiscal year, according to official forecasts, and then fall to 3.6 per cent next year.
The additional yield demanded by investors in UK debt compared with German 10-year bonds rose above 2.3 percentage points last month, the biggest premium since 1990 and above even the level reached after former Prime Minister Liz Truss’s ill-fated 2022 “mini” Budget.
France’s spread with Germany has risen to its highest since the Eurozone debt crisis, reaching 0.9 percentage points in November. Ten-year US Treasury yields have jumped from 3.6 per cent in September to nearly 4.7 per cent.
Those moves have come even as central banks have begun to lower interest rates — which are typically the main driver of bond yields — as the post-pandemic surge in inflation faded. Selling has been concentrated in longer-dated debt, which is the most sensitive to the scale of issuance.
“I like to think that the government bond market is the grown-up in the room,” said April LaRusse, head of investment specialists at Insight Investment.
Usually bond investors provide a “low rumbling in the background” of policymaking, but events in the UK and France have demonstrated how they have begun to increase the pressure, LaRusse added. “They are going to tell governments [when] they are pushing things too far.”
The sell-offs have led to comparisons with so-called “bond vigilantes” — a group of investors that drove changes in US fiscal policy in the 1990s by forcing yields higher but which has more recently been dormant. While tensions are not at those levels, fund managers say there has been a decisive shift away from the era of low rates and quantitative easing following the global financial crisis, when central bank buying was the dominant force in bond markets.
“Very high debt levels” in countries such as the UK and France have encouraged investors to reprise their former role as “the police for triggering responsible fiscal policy”, said Peder Beck-Friis, an economist at fund firm Pimco, which manages $2tn.
“You don’t need large shocks to fiscal policy or political news to generate quite a [lot of] volatility” in markets, he added.
As China sells down some of its stock of foreign debt, and central banks reduce their balance sheets, “we no longer have a price-insensitive buyer” of bonds, said Niall O’Sullivan, global solutions chief investment officer at Mercer. “[Bond markets] are more of a controlling force” as a result, he added.
A number of governments are borrowing heavily to try to boost growth, and failing to reassure markets with their plans to rein in fiscal deficits.
The Bank for International Settlements warned in December that rising debt levels were “one of the biggest threats, if not the biggest threat going forward for the global economy”, and higher borrowing costs were a sign that markets realise they will have to absorb more debt.
In the UK, investors have warned that higher borrowing costs are making 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 a “negative feedback loop between higher deficits, a higher debt load and higher financing costs”.
Bondholder activism is even beginning to make a mark on the $26tn US government bond market, where the dollar’s status as the global reserve currency means large numbers of investors around the world have little choice but to buy Treasuries.
Pimco said last month it was cutting exposure to long-dated US debt over sustainability concerns, adding that bond vigilantism would be felt gradually.
“There is no organised group of vigilantes poised to act at a specific debt threshold; shifts in investor behaviour typically occur at the margin and over time,” the asset manager said.
However, Trump’s tax-cutting pledges could prompt such a shift, if he delivers on them in full, some investors say.
“If the Republicans try to put in everything discussed during the campaign, without paying for most of them, to me that would really raise the spectre of the bond vigilantes coming back,” said Sonal Desai, CIO for fixed income at asset manager Franklin Templeton.
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