The bond vigilantes are back

The bond vigilantes are back

Last Thursday the US House of Representatives passed president Trump’s tax-cutting budget bill by a single vote. The bill now goes to the Senate for ratification.

• The passage of the bill through the lower house of Congress has stoked concerns in the US bond market about the state of America’s public finances. Last Thursday the yield or interest rate on 30-year US government bonds, which moves inversely with bond prices, rose above its 2023 peak, to the highest level since 2007. The sell-off came in the wake of an auction of US government debt in which investor demand had fallen short of expectations. Such auctions, in which the US Treasury issues new debt, test market sentiment. On this occasion it was lacklustre.

• Markets are volatile and the mood can quickly change. Yet last week’s events seem symptomatic of a wider shift. Earlier this month the credit rating agency Moody’s stripped the US of the highest triple-A credit rating on expectations of a widening budget deficit. The FT reported last week that investors are diversifying bond portfolios away from the US and quoted Vincent Mortier, chief investment officer at Amundi: “The US is no longer the ultimate and only perceived safe haven. The country has become the home of extreme fiscal indiscipline". The Bank for International Settlements – the body that represents the world’s central banks – said last December that rising levels of government debt were “one of the biggest threats, if not the biggest threat… to the global economy”. 

• It's been a while since I’ve heard the term, but talk of “bond vigilantes” is making a comeback. The phrase was coined by the US economist, Ed Yardeni, in the 1980s to describe the way in which investors protest against excessive government borrowing or lax monetary policy by selling government bonds. Selling pressure drives prices down and yields up, raising the costs of borrowing for government. Yardeni argued that such pressure from investors in the 1980s forced the Federal Reserve to act more vigorously against inflation. 

• The bond vigilantes seem to have been asleep for most of the last 25 years. Government borrowing in most western economies has ballooned yet, until 2020, borrowing costs kept falling. Appetite for government bonds remained strong as the global stock of debt soared. Even when high levels of government borrowing have been combined with high inflation, as has been the case in the last four years, investors have generally been pretty happy to buy government debt.

• Lacklustre demand in last week’s US Treasury auction and a spike in US yields suggest that the bond vigilantes are making a comeback. This is not just a US phenomenon.

• Japanese bond yields, which have been on the floor for decades, have shot up especially for longer-dated bonds. Japanese inflation is running at 3.6%, a remarkably high rate for a country long associated with deflation. Markets are focusing on Japan's fiscal position, with debt well in excess of 200% of GDP, by far the highest in the industrialised world. At the other end of the spectrum, German debt stands at just over 60% of GDP. But Germany’s borrowing costs have also risen this year in response to a constitutional change that allows for effectively unlimited debt-financed spending on defence.  

• Most countries issue debt, but the US is by far the world’s biggest borrower, and the stock of US government debt dwarfs that of other countries. US Treasuries are the bedrock asset of the global financial system. America’s borrowing costs affect the world.

• The big issue, as we flagged in last week’s briefing, is the trajectory of US government borrowing. America’s stock of debt relative to GDP has more than tripled in the past 20 years. The budget bill renews and extends Mr Trump’s 2017 tax cuts. Although it also cuts subsidies for renewables and support for lower-income households through Medicaid and food stamps, the savings do not remotely cover the additional cost of tax cuts. The result is that the budget bill would raise US debt from 100% of GDP today to 134% by 2034 and 211% by 2055.

• The question is whether investors will be willing to finance this level of spending, and at what price. We’re likely to be hearing a lot more from the bond vigilantes.

OUR REVIEW OF LAST WEEK’S NEWS
The UK FTSE 100 equity index ended the week up 0.4% at 8,718.

Economics

• Donald Trump agreed to delay his threatened 50% tariff rate on the EU and extend trade negotiations until 9 July following a call with EU Commission president Ursula von der Leyen
• Mr Trump also threatened Apple with tariffs of at least 25% on iPhones made overseas
• Estimates of business activity in May from surveys of purchasing managers indicated rising growth in the US while activity declined across the UK and EU
• The UK and EU reached an agreement that includes provisions to ease barriers for UK food exports to the EU in return for EU access to UK fishing waters. The deal is expected to add £9bn to the UK economy by 2040 
• UK inflation increased to a greater-than-expected 3.5% in the year to April, a 15-month high, driven by higher taxes and energy bills
• The UK domestic energy price cap will fall by 7% from July, according to the energy regulator Ofgem, the first cut since July 2024
• The Bank of England’s chief economist, Huw Pill, warned that the Bank was cutting rates too quickly and risked inflation rising further above target
• UK net migration nearly halved in 2024 compared with the previous year, from 860,000 to 431,000, following the imposition of stricter migration rules effective from the end of 2023
• UK retail sales volumes rose more than expected in April, by 1.2% compared with the previous month, driven by the warm weather boosting food sales 
• Consumer confidence in the UK and euro area improved in May, partly reversing the decline in sentiment seen last month
• German business sentiment continued to improve in May, according to the ifo Business Climate survey as expectations improved. The ifo Institute commented that Germany “is slowly regaining its footing”
• Polish equities have risen over 28% this year, one of the fastest rates globally, due to Poland’s relatively insulated position against US tariffs and expectations that higher European defence spending will boost growth
• Applications for New Zealand’s “golden visas” have surged, primarily due to higher applications from the US, following a relaxation of rules aimed at attracting more foreign direct investment

Business

• Semiconductor manufacturer Nvidia announced plans for additional investment in Taiwan, including constructing an AI supercomputer, despite Taiwan’s geopolitical tensions and global trade uncertainties
• Chinese electric car manufacturer BYD sold more vehicles across Europe than US rival Tesla for the first time last month, according to Jato Dynamics research group, highlighting the rising competition from Chinese auto manufacturers
• Investment management company Redbird Capital Partners agreed to buy the Telegraph Media Group for £500m, following the UK government’s previous concerns over foreign ownership of the UK newspaper
• UK real estate company British Land reported a rise in demand for older office space across London, driven by rising rental costs and limited supply of new offices across the capital 
• Unilever announced an £80m investment in the UK to develop its fragrance capabilities

Global and political developments

• Israeli prime minister Benjamin Netanyahu said Israel’s aim in its latest military campaign is “to take over all of the territory of Gaza”
• Mr Trump announced plans for a US “golden dome” missile defence system, inspired by Israel’s Iron Dome, with initial costs of around $175bn
• UK prime minister Keir Starmer signalled a partial reversal of cuts to pensioners’ winter fuel payments following significant cross-party opposition

And finally… a small French town broke the world record for gathering the largest number of people dressed as Smurfs. A total of 3,076 people, with painted blue faces and white hats, were involved – sacre-bleu!