Analysis: Bond vigilantes mean business, government better be careful

LONDON, Oct 17 (Reuters) – The spectacle of Britain’s new finance minister tearing up his leader’s economic policy on Monday made something very clear – the bond market vigilantes are back, bold and the government’s most Good to pay attention.

It took only three weeks for the market to force Britain, the world’s sixth-largest economy and issuer of a reserve currency, to take a sharp turn.

Attempts to cut taxes at a time when the country’s finances already have a huge hole has sent borrowing costs soaring in the UK, requiring the Bank of England to step in and former finance minister Kwasi Kwarteng losing his job.

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The damage to UK government bonds, or gilts, continued even after Monday’s reversal. Yields on 10-year gilts remained around 46 basis points above their pre-September 2 levels. 23 Mini-budget, 30-year Treasury yields are about 55 basis points higher, while the cost of mortgage rates is still much higher.

“It’s really not the right time to experiment with fiscal policy,” AXA chief economist Gilles Moec said of the UK move, assessing Monday’s U-turn may have appeased the “current bond vigilantes”.

The term bond self-defense refers to debt investors imposing fiscal discipline on profligate governments by forcing their borrowing costs to be higher.

In another sign that Treasury Secretary Jeremy Hunt is trying to restore credibility, he announced the creation of a new Economic Advisory Council, comprising four financial experts: Rupert Harrison, former Treasury Secretary George Osborne’s Former chief of staff, now working for BlackRock, former Bank of England member Sushil Wadhwani, another former Bank of England official Gertjan Vlieghe is now in New York at hedge fund Element Capital and JPMorgan strategist Karen Ward.

Reuters Graphics

The surge in gilt yields has been more severe than comparable German or U.S. bonds, but senior economists note that London is not the only place to be concerned.

That’s because global interest rates are rising and central banks are no longer executing bond-buying programs that have long depressed government borrowing costs.

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

That’s about four times the rate at which money was pulled from the system in 2018-19 when the Fed tried to end its financial crisis stimulus.

Ed Yardeni, who coined the term bond vigilantes in the early 1980s, wrote on his blog: “They’re Baaaack!” when the first holocaust broke out in the UK last month.

He sees a surge in U.S. mortgage rates this year to their highest levels since 2008 as another potential problem, with debt-laden Italy likely to be targeted if Europe suffers a full-blown energy crisis this winter.

“Central banks align bond vigilantes with ZIRP, NIRP and QE,” Yardney said of the ultra-low interest rates and stimulus in the aftermath of the financial crisis. “No more: They’re back in the saddle and riding very high”.


With Russia cutting gas supplies, many European governments are torn between the need to protect households and companies from energy shocks and the need to fight record inflation and keep public finances sustainable.

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

The victory of right-wing parties in September’s national election has also sparked concerns as they campaign for higher pensions, welfare payments and a 15 percent flat tax on self-employed people, without saying how they will be funded.

Hungary also showed that emerging markets are always subject to the market.

Its central bank was forced to raise some rates as high as 25% on Friday after trying to end the rate hike cycle just a week ago, throwing Flynn into chaos again.

Warning to shoot?

Still, the crisis over Britain’s tiny budget has sparked global panic.

Even US President Joe Biden spoke bond vigilante language over the weekend, noting that he is not the only one who thinks the UK plan is “wrong”.

Markets barely flinched when Germany, the euro zone’s largest economy and benchmark bond issuer, last month unveiled a 200 billion-euro package funded by new borrowing to help cushion the blow from the energy crisis.

Analysts said Germany’s package focused on energy support and was likely to unfold over a longer period, explaining why Germany’s borrowing plan did not spark market jitters like Britain’s plan in September.

“This is probably the biggest example of bond vigilante activity in practice,” said Antonio Cavarero, investment director at Generali Insurance Asset Management. “If this can happen in the UK, it can happen in any other economy.”

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

Our Standard: The Thomson Reuters Trust Principles.

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