Analysis: Bond vigilantes mean business, governments better beware

LONDON, Oct 17 (Reuters) – The sight of the new UK Treasury Secretary shredding his leader’s economic policy on Monday made something very clear – the bond market vigilantes are back, they’re bold and governments had better watch out.

It took just three weeks for the markets to force Britain, the world’s sixth largest economy and an issuer of one of its reserve currencies, into a screeching about-face.

Attempting to lower taxes when there were already large gaps in government finances had pushed up the cost of borrowing in the UK, forcing the Bank of England to step in and the loss of former Finance Minister Kwasi Kwarteng.

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Even after Monday’s reversal, the damage to UK government bonds or gilts continues. Ten-year government bond yields are still around 46 basis points above their pre-September 23 mini-budget levels, 30-year government bond yields are around 55 basis points higher and mortgage rates remain significantly higher.

“It really isn’t the time to experiment with fiscal policy,” AXA chief economist Gilles Moec said of Britain’s moves, assessing Monday’s about-face “may have placated Bond vigilantes for now.”

The term bond vigilantes refers to debt investors who impose fiscal discipline on profligate governments by driving up their borrowing costs.

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In another sign that Treasury Secretary Jeremy Hunt is trying to restore credibility, he announced a new business advisory board consisting of four financial experts: Rupert Harrison, former chief of staff to ex-Treasury Secretary George Osborne who now works for BlackRock, former BoE member Sushil Wadhwani, another former BoE official, Gertjan Vlieghe, now at New York hedge fund Element Capital, and JPMorgan strategist Karen Ward.

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Gilt yields have risen more sharply than comparable German or US bonds, but veteran economists warn that London is not the only target in the crosshairs.

That’s because interest rates are rising around the world and central banks are no longer conducting the asset purchase programs that have long kept government bond costs fixed.

Morgan Stanley estimates that the balance sheets of the four major central banks – the Federal Reserve, the European Central Bank, the Bank of Japan and the BoE – will shrink by around $4 trillion by the end of 2023.

That’s about four times the rate of stimulus that was pulled from the system in 2018-19 as the Fed attempted to end its stimulus from the financial crisis.

Ed Yardeni, who coined the term Bond Vigilantes in the early 1980s, penned a blog post entitled ‘They’re Baaaack!’ when Britain’s chaos first erupted last month.

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He believes this year’s rise in US mortgage rates to their highest level since 2008 is another potential concern and that debt-ridden Italy could be a target if Europe suffers a full-blown energy crisis this winter.

“Central banks kept the bond vigilantes in check with ZIRP, NIRP and QE,” Yardeni said, referring to the post-financial crisis years of ultra-low interest rates and stimulus. “Not anymore: You’re back in the saddle and riding high”.


Many European governments are torn between the need to protect homes and businesses from the energy shock as Russia cuts gas supplies and the need to fight record inflation and keep public finances sustainable.

Italy has long been a concern about its huge public debt of around 150% of GDP and slow economic growth.

A victory for right-wing parties in September’s general election also fueled fears after they lobbied for higher pensions, welfare benefits and a flat tax of 15% for the self-employed without saying how to fund them.

Hungary has also shown that emerging markets are always at the mercy of the markets.

Its central bank was forced to hike some of its interest rates by as much as 25% on Friday after trying to end its cycle of rate hikes just a week earlier, sending the forint into another slide.

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Still, the crisis sparked by Britain’s mini-budget has sparked dismay around the world.

Even US President Joe Biden spoke the language of Bond vigilantes over the weekend, noting he wasn’t the only one who thought the UK plan was a “mistake”.

Markets barely flinched when Germany, the eurozone’s largest economy and its benchmark bond issuer, unveiled a €200 billion package last month, funded by new borrowing to cushion the blow of the energy crisis.

Germany’s package focused on energy support and would likely be spread out over a longer period of time, analysts said, explaining why Germany’s borrowing plans didn’t spark market turmoil like Britain’s September plan did.

“This is probably the largest real-world example of Bond Vigilantes’ activities,” said Antonio Cavarero, head of investments at Generali Insurance Asset Management. “If that can happen to the UK, it can happen to any other economy.”

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Additional reporting by Dhara Ranasinghe; Adaptation by Dhara Ranasinghe and David Evans

Our standards: The Thomson Reuters Trust Principles.


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