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When bond markets get sticky, it's no use being the ugliest horse in the glue factory. Unfortunately, that is the role the UK is now playing.
It's been a dismal start to the year in global bonds, but again contrary to what analysts and professional investors have told us to expect from 2025. From the US to Japan and almost everywhere in between, developed-market government bond prices fell, yields and borrowing costs have risen – a blow to countries that are holding limits in their hands as investors seek funding.
However, the UK is unfortunate to suffer more than most, and with the still recent memory of the sow crisis in 2022, alarm bells are ringing. This week there was a curious new wrinkle in the story when the mercifully short-lived prime minister, Liz Truss, said through her lawyers that it was unfair to suggest she disrupted the economy at the time. This is a strange move that reflects poor familiarity with The Streisand Effect.
In any case, the pressing question is whether we are at the beginning of a new one piglets bonfire. The short answer in my opinion is no. The longer answer is: it's largely beyond the reach of British politicians anyway.
To be clear, this week's sow slump is a serious episode. Not all, but many investors have been cooling off on UK debt for some time, spooked by signs of lingering inflation that will make it difficult for the Bank of England to keep cutting interest rates. Ten-year yields have risen by about half a percentage point since the new government budget at the end of October. That's a decent chunk of bond ground that represents a big drop in prices, and includes some sizable declines in the opening days of this week to push long-term yields to their highest since 1998.
More alarmingly, the pound also took a knock, suggesting this is not just a case of investors reassessing their view of what and when the BoE will do next, but a flight from UK risk more broadly. (Even Gregg's share price has taken a nosedive, and if you can't bet on Brits finding pennies for steaks and sausages, something's seriously wrong.)
Declaring the sow shakeout a new crisis suits the political agenda of some observers. But context is important here. In general, shares are up, not down, so far this young year, reflecting the close relationship between the FTSE 100 index, crammed with overseas profits, and a weaker pound. The same was not true in 2022 when the FTSE was smoking. Yes, a half-point increase in 10-year gilt yields is a lot since the budget. In 2022, however, they jumped by more in three days. The two things simply cannot be compared. And the pound is certainly weaker, but so is the euro, yen and everything else except the mighty dollar.
Here's the key. The real story is the rise in bond yields globally as the US economy continues to grow ahead of other developed countries and inflation remains above target. In mid-December, The Federal Reserve System stated Rate cuts would not be as rapid as investors previously thought. A few weeks ago, markets reflected expectations that the Fed would cut interest rates several times in the early months of this year. Now we're looking at a chop in the summer, probably, and maybe another later. Friday's surprisingly robust US jobs data added even more fuel.
US bond yields, which exert a huge gravitational pull on the rest of global debt markets, are also pulling higher. Benchmark U.S. 10-year yields are up nearly 0.2 percentage points so far this year, outpacing the rest of the market. The UK is in the crosshairs as weaker gilts put Chancellor Rachel Reeves in an uncomfortable spot where she may have to cut spending or raise taxes. But yields in fiscally austere Germany rose by a similar rate to the UK without much fanfare.
In addition to U.S. economic performance, the global pressure on bonds stems from what Nobel Prize-winning economist Paul Krugman this week described as “insanity premium” on US bond yields.
“A rise in long-term rates like the 10-year Treasury rate could reflect a terrible, creeping suspicion that Donald Trump actually believes the crazy things he says about economic policy and will act on those beliefs,” Krugman wrote on his blog. a reference to high trade tariffs, tax cuts and potential mass deportations that point to a renewed rise in US inflation.
So what stops the rot? My feeling is that it will stop on its own. U.S. Treasuries will no longer decline in price once they become an irresistible bargain for investors. That is likely to be the case if and when 10-year yields move closer to 5 percent from the current near 4.8. The same probably applies to the UK, which for all its woes is almost unlikely to default on its debt. Large round numbers, in this case five, have a strong tendency to hammer home this message.
But the embarrassing scenes in bond markets this week are a reminder to Reeves and the rest of us that the U.S. is driving the car for developed markets. We are only passengers and must hope that he steers carefully.
