The author is a former global head of asset allocation at a fund manager
Governments have been slaves to the bond markets for centuries. But the term “bond vigilante” was coined just 40 years ago, when economist and Wall Street analyst Ed Yardeni argued that if politicians failed to regulate the US economy, bond investors would step in.
Last September investors in UK government bonds did not so much intervene as freak out. But this is semantics. The results – the reversal of heterodox policy measures and the resignation of Liz Truss as prime minister – have been touted as offerings to bond vigilantism.
This week, UK government bond yields have surpassed the levels that caused last year’s financial chaos. But, unlike in Fall 2022, there has been a notable absence of market panic. Fund managers have been falling on themselves declare gilts attractive. And instead of requiring the Bank of England to bail them out, defined benefit pension schemes have entered record surplus.
What has changed? Today higher bond yields are a feature of politics. They were a bug last time.
The current period of weakness in bond prices can be seen as investors reevaluate their best guesses about the likely path of BoE interest rates in the context of the data. Price inflation in the UK has been stubbornly sticky and the labor market has been consistently strong. As a result, it seems likely that the central bank will raise rates higher than previously thought and keep them higher for longer. The September slump, by contrast, saw then-chancellor Kwasi Kwarteng accidentally slip into political heterodoxy trigger a series of leveraged positions which triggered a “rushing dynamic” in the gilt market.
Higher returns come at a cost, no matter how you get them.
There are over 400,000 Mortgage holders in the UK are renewing their fixed term mortgages every quarter this year, mainly from offers with rates below 2.5%. The effects of higher bond yields on those in line to refinance will range from simply costly to personally ruinous.
The costs are also being felt by the government. As the issuer of its own currency, the financial constraints facing the UK government are different from those faced by households. To ensure that public finances are managed to avoid the risk of default or inflation, Britain, like most countries, applies a variety of fiscal rules. Their latest incarnation focuses on reducing public sector net debt and balancing the budget in the third year of a five-year horizon.
Despite rising bond yields, achieving the debt target in the near term shouldn’t be difficult. Only a fraction of public debt is linked to inflation, while government revenues and gross domestic product are overwhelmingly so. This means that the debt is in the process of being inflated.
And despite a high debt stock, interest costs as a percentage of GDP remain low, putting little pressure on the budget. This is partly due to the effect of locking up so much low-yield long-term debt. This is not a bad place to stay.
As a general rule, interest costs on public debt typically had to reach 5% of GDP before encountering real alarm in finance ministries with fiscal adjustment programs tending to follow. We saw this in Canada in the mid-1980s and again in the mid-1990s, in Italy’s 1988 and 1995 plans, as well as in the UK’s 1976 and 1980 IMF programme.medium-term financial strategy”. We are still a long way from these levels, although the longer yields remain high, the greater the pressure on the cost of debt service on the broader budget.
The gilt market is increasingly important to our lives. As Truss has shown, ignoring it can be costly. But listening too much to the bondholder lobby, whose financial interests are maximized when economic growth is absent and disinflation is rampant, also comes with costs. Fear of bond market monsters is a bad reason to delay investing in vital infrastructure or the green transition.
Additional piece
The bond vigilantes have long exerted their influence over governments, shaping economic policies and financial markets. In recent years, their power seems to have intensified, as governments around the world have become increasingly reliant on borrowing to finance their spending. This has raised concerns among investors and policymakers about the sustainability of public debt levels and the potential for a bond market crisis.
The recent turmoil in the UK government bond market has reignited the debate over the power of the bond vigilantes. With bond yields reaching new highs, some have argued that the bond market is sounding the alarm on the UK’s fiscal path and pushing the government to adopt more prudent policies. Others, however, have dismissed the market’s reaction as nothing more than a temporary blip, driven by technical factors and short-term market dynamics.
So, who are these bond vigilantes and what role do they play in shaping government policies and financial markets? The term “bond vigilante” was coined by economist Ed Yardeni in the 1980s to describe investors who use their influence in the bond market to discipline governments and demand fiscal responsibility. These investors, typically large institutional investors like pension funds and asset managers, monitor government debt levels, inflation expectations, and policy decisions, and adjust their bond holdings accordingly.
When bond yields rise, it reflects a decrease in bond prices, indicating that investors are demanding higher returns to compensate for the perceived increase in risk. This can happen when investors lose confidence in a government’s ability to manage its finances, leading to higher borrowing costs and potentially triggering a debt crisis. The bond vigilantes, by selling their bond holdings or demanding higher yields, can put pressure on governments to adopt fiscal austerity measures, reduce budget deficits, and address structural imbalances in the economy.
The power of the bond vigilantes stems from their ability to influence market sentiment and trigger a self-fulfilling prophecy. If investors believe that a government’s debt levels are unsustainable or that inflationary pressures are building up, they may start to sell their bonds, driving up yields and making it more expensive for the government to borrow. This, in turn, can lead to higher interest payments, larger budget deficits, and a downward spiral of fiscal deterioration. Governments, therefore, have an incentive to heed the signals from the bond market and take steps
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The author is a former global head of asset allocation at a fund manager
Governments have been slaves to the bond markets for centuries. But the term “bond vigilante” was coined just 40 years ago, when economist and Wall Street analyst Ed Yardeni argued that if politicians failed to regulate the US economy, bond investors would step in.
Last September investors in UK government bonds did not so much intervene as freak out. But this is semantics. The results – the reversal of heterodox policy measures and the resignation of Liz Truss as prime minister – have been touted as offerings to bond vigilantism.
This week, UK government bond yields have surpassed the levels that caused last year’s financial chaos. But, unlike in Fall 2022, there has been a notable absence of market panic. Fund managers have been falling on themselves declare gilts attractive. And instead of requiring the Bank of England to bail them out, defined benefit pension schemes have entered record surplus.
What has changed? Today higher bond yields are a feature of politics. They were a bug last time.
The current period of weakness in bond prices can be seen as investors reevaluate their best guesses about the likely path of BoE interest rates in the context of the data. Price inflation in the UK has been stubbornly sticky and the labor market has been consistently strong. As a result, it seems likely that the central bank will raise rates higher than previously thought and keep them higher for longer. The September slump, by contrast, saw then-chancellor Kwasi Kwarteng accidentally slip into political heterodoxy trigger a series of leveraged positions which triggered a “rushing dynamic” in the gilt market.
Higher returns come at a cost, no matter how you get them.
There are over 400,000 Mortgage holders in the UK are renewing their fixed term mortgages every quarter this year, mainly from offers with rates below 2.5%. The effects of higher bond yields on those in line to refinance will range from simply costly to personally ruinous.
The costs are also being felt by the government. As the issuer of its own currency, the financial constraints facing the UK government are different from those faced by households. To ensure that public finances are managed to avoid the risk of default or inflation, Britain, like most countries, applies a variety of fiscal rules. Their latest incarnation focuses on reducing public sector net debt and balancing the budget in the third year of a five-year horizon.
Despite rising bond yields, achieving the debt target in the near term shouldn’t be difficult. Only a fraction of public debt is linked to inflation, while government revenues and gross domestic product are overwhelmingly so. This means that the debt is in the process of being inflated.
And despite a high debt stock, interest costs as a percentage of GDP remain low, putting little pressure on the budget. This is partly due to the effect of locking up so much low-yield long-term debt. This is not a bad place to stay.
As a general rule, interest costs on public debt typically had to reach 5% of GDP before encountering real alarm in finance ministries with fiscal adjustment programs tending to follow. We saw this in Canada in the mid-1980s and again in the mid-1990s, in Italy’s 1988 and 1995 plans, as well as in the UK’s 1976 and 1980 IMF programme.medium-term financial strategy”. We are still a long way from these levels, although the longer yields remain high, the greater the pressure on the cost of debt service on the broader budget.
The gilt market is increasingly important to our lives. As Truss has shown, ignoring it can be costly. But listening too much to the bondholder lobby, whose financial interests are maximized when economic growth is absent and disinflation is rampant, also comes with costs. Fear of bond market monsters is a bad reason to delay investing in vital infrastructure or the green transition.
https://www.ft.com/content/d71d0f43-c5a0-4945-b6c9-ef3dce7f806a
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