As tension grips the US bond market, with yields climbing again and already targeting 5%, all eyes have once again fallen on fixed income. However, the situation of North American securities has overshadowed another rampant rise in the debt yields of another economy in which there is already open talk that they may bring a crisis or, at least, direct budget consequences in the short term. This is the case of the United Kingdom, whose bonds are in free fall and, known as gilts, are already generating serious problems for the government and the economy.
The performance of ten-year bonds reached 4.925% this Thursday, its highest level since 2008 after rising 20 basis points in a matter of three days. The interest rate on 30-year bonds has risen even further, to 5.471%, reaching its highest levels since 1998. Former Bank of England committee member Martin Weale commented in an interview with Bloomberg that, despite who does not see a situation comparable to the unappealable fall of the gilts with Lizz Truss’s mini-budget, which forced her departure from the government, she does see some similarities with the debt crisis 1976.
Then, as now, the pound fell thanks to bonds. Just this week the pound sterling has dropped 1.7% in the exchange with the dollar. Higher debt yields generally support the currency. In 1976 this combination destroyed the government’s budgetary margin, forcing it to request a bailout from the International Monetary Fund. Now the situation is not so extreme but, according to its calculations, the increase in debt threatens to wipe out the 9.9 billion pounds of budget margin, in an update that would be given in March.
In the presentation of her budget, the Minister of the Exchequer, Rachel Reeves, promised that she would finance public spending with tax revenues, at least to a large extent. The idea was to maintain solid public investment while eliminating the powerful fiscal deficit of 23 billion that was financed with a large tax increase. In that sense, a limited debt margin was imposed for its plan with financing goals through debt for the year 2030. A very narrow margin that only gives those 9.9 billion of pounds. A commitment that the debt market could overthrow if the bonds continue their current behavior and that would force two possibilities: either ignore these limits and return to the deficit or adjust the accounts with spending cuts or tax increases.
Debt interest plays a totally decisive role in the budgetary balance of the European nation. Not in vain The government pays more than 100,000 million in interest dollars per year. That’s why Deutsche Bank estimates new UK borrowing will be £10bn higher than expected when Reeves presented his budget, while Bloomberg Economics’ Dan Hanson estimates the additional cost of rising yields It will be approximately 12,000 million. A difference that is shaking those memories and, although the situation is not so bad, it certainly opens the door to a new source of economic instability for London.
“Not since 1976 have we seen a toxic combination of a sharp fall in sterling and a rise in long-term interest rates, which led to the IMF bailout“said Weale, now professor of economics at King’s College London. “We are not in that position so far, but it must be one of the chancellor’s nightmares.”
From Pimco, the largest bond investor in the world, with 2 trillion dollars under management, they believe that the Minister of Finance will have to find more money to save this situation. “If current trends of rising yields and slowing growth continue, the chances of the government cuts spending or raise taxes to comply with their new tax rules.”
Capital Economics is clear that the shift in the bond market will have an impact on budgets. “Rachel Reeves’ room for maneuver is shrinking rapidly as long-term government bond yields rise. In the midst of a wave of global bond sales,” says Ruth Gregory, the firm’s chief economist for the United Kingdom. According to the expert, the recent movements alone would have already reduced the budget margin by nearly 1 billion pounds.
The Prime Minister of the United Kingdom himself has been called to parliament to respond to this issue urgently this Friday to answer what the response will be about “the increasing pressure of borrowing costs in public finances,” commented Reuters. Chief Secretary to the Treasury, Darren Jones, in the House of Commons has responded to this concern by claiming that “British government bond markets continue to function in an orderly manner. “It is normal for the price and yields of government bonds to vary when there are broader movements in financial markets.”
Why are bonds falling?
The recent rise in British bond yields has largely come from the massive liquidation that occurred in the global fixed income market (highlighting the US and the UK itself). At least that’s what experts think like Chris Turner, an ING analyst, who explains in his latest report that “the liquidation of the bond market global market struck a chord in the government bond market.” Furthermore, “the widening of the spread” prompted investors to reduce their position in the pound sterling.
Michael Tucker, an analyst at the Dutch firm, explains that this fully justifies “the highs of 1998” Well, “although we believe that structurally they should be lower” there are factors that prevent yields from falling “at least for a time.” Tucker specifically talks about “stars aligning” against British debt. The factors include “Labour’s spending ambitions, persistent inflation, higher rates in the United States and supply pressures.”
ING assumes that there will be a very high bid for “the Labor government’s spending” but also for the “continued qualitative regulation of the Bank of England.” The latter is especially important given that to combat inflation the central bank has chosen to use its balance sheet more aggressively than other institutions. In that sense by reducing by nearly 100 billion pounds The same year, the market finds itself with the loss of a major player to absorb all that supply of bonds that the market must now take.
“The situation could become especially bleak for bonds if US employment data is especially strong”
In that sense they believe that unlike the darkest hours with Lizz Truss now “there is good foreign demand which reduces the risks of a similar crisis” therefore They rule out “massive sales.” BNY also denies a possible comparison with that experience. “We have already seen falls in bonds, at some point they will hit bottom but, although there are problems in the United Kingdom, I think comparing the situation with 2022 is exaggerating.”
Although they undoubtedly see a clear impact of US bonds on their counterparts on the other side of the Atlantic. “Higher US Treasury yields also have contributed significantly to the increase in yields“, they comment from ING. The reason is that “The recent rise in US Treasury bond yields is consistent with our concerns about inflationary pressures under US President-elect Donald Trump and high government deficits. “.
From PIMCO they agree that the US is being the key to explaining this situation. “Although UK specific factors, like the budget, have contributed to the increase, most of the increase has been driven by increases in US Treasury bond yields during the same period,” the firm explained in an interview with Reuters. Cheaper securities and with better yields in Washington represent a magnet for fixed income investors who might otherwise have opted for gilts. This would add to the problems that exist in the United Kingdom, according to PIMCO, “both weaker growth and interest rates. higher put pressure on public finances.
In that sense, they believe that the British debt market could face a real match ball this Friday. From TD securities they comment that “the situation could become especially bleak for bonds if US employment data is particularly strong.” This outlook would give the Fed strength to hold rates somewhat, dragging down US bond yields and, consequently, taking gilts with them in the process. In any case, it is no longer an issue that affects investors, the United Kingdom begins 2025 by risking its budgetary stability in the bond market. Although it is far from a crisis, surviving the ‘gilt rebellion’ could be. key to the plans of a Labor party that has entrusted itself to these budgets to reactivate the country’s economy at a difficult time.
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