Bond Market Crisis Predicted

The relentless rise in government bond yields has become headline news as a crisis in which governments will be forced to slash public spending to reduce deficits and stop the rise in debt-to-GDP ratios is widely predicted.

Bond Vigilantes Theory

The term 'bond vigilantes' describes investors who keep governments in check when deficits, debt and inflation threaten, and their boycott of bond markets would force yields higher and trigger a fiscal crisis.

James Carville's Quote

James Carville, Bill Clinton's political adviser, quipped, 'I used to think that if there was reincarnation, I wanted to come back as the President or the Pope... But now I would like to come back as the bond market. You can intimidate everyone'.

“I used to think that if there was reincarnation, I wanted to come back as the President or the Pope... But now I would like to come back as the bond market. You can intimidate everyone”

Current Bond Market Concerns

Today, investors are worried by four factors: rising inflation led by oil and gas prices, governments' inability to control budget deficits, escalating national debt, and the impact on the economy and markets.

Oil and Gas Price Trends

Oil prices in real terms are little higher than their average this century ($95 a barrel for Brent), with wholesale natural gas prices rising more than oil prices due to refining capacity shortages.

Why Bond Yields Have Risen

Higher energy prices have pushed up inflation without a wage-price spiral, but real interest rates have risen above 2% since 2019, driven by increased capital demand and government borrowing.

Debt-to-GDP Ratios

The ratio of government debt to GDP in most developed countries rose sharply after the 2008 financial crisis and during Covid, but has fallen as economies recovered, with the trend being broadly flat or gently rising.

Bond Market Outlook

The current level of pessimism suggests the sell-off in bond markets is overdone, with oil and gas prices expected to fall, inflation to drop, and real interest rates to subside.

US Federal Reserve Action

The US Federal Reserve, but not the Bank of England, realises that raising short-term rates demonstrates inflation-fighting credibility and will bring down bond yields.

UK Gilts Value

UK ten-year gilts yielding over 5% and 30-year gilts yielding nearly 6% look good value, but every period of Labour government has resulted in a devaluation of sterling.

Japanese Bonds Alternative

Japanese government bonds yield 4% with a seriously undervalued currency, though the debt-to-GDP ratio looks intimidating at 230% with 90% domestically owned.