Chapter 1: What are the current trends impacting UK bond yields?
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Listen to the Flipside on your favorite platform. Cushkin. Stock markets are so hot right now. People keep telling me with a straight face that the biggest risk in stocks today is that we're not taking enough risk in stocks. Let's see how that one ages, shall we? Anyway, meanwhile, bonds not happy like they're really not happy.
Bond prices are down, which means borrowing costs are cranking higher all over the world. Meanwhile, the UK has done what it does best and manufactured a political crisis out of thin air. So UK government bonds, or gilts, are really feeling the heat. Today on the show, what's bothering bonds, why do normies care, and how can the UK avoid making a bad situation worse?
This is Unhedged, the markets and finance podcast from the Financial Times. I'm Pushkin. I'm Katie Martin, a markets columnist down in the dungeon at FT Towers in London, which is inexplicably freezing cold.
I'm joined, as usual, by the big man in New York City, Mr. Rob Armstrong. Rob, do you have your special chair again?
Yes, they've got me locked in place again.
Good.
This is what it's come to.
I'm joined right here in the London studio by our newbie on the Unhedged newsletter, Darren McFadden. You've been at the FT for like a month. You came from the Bank of England. You came from a proper job. How are you liking our funny ways? Is it a very different place to be?
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Chapter 2: How does the UK's political situation affect borrowing costs?
Greece uses the euro. France uses the euro. Germany, yada, yada. We use sterling. So it's like it's not quite comparing apples with apples. And we don't have the same central bank. So we don't have the same base rate between the two. So, like, European benchmark interest rates are like 2%. Like, yeah. And, you know, we're at, what are we at, Daraa?
We are at 4.25. Derek actually set that interest rate before he quit that job to join us here at The Unedged. That was his last act. Thankfully, I never had to work on monetary policy.
too hard it's too hard so look we're a different we're at completely different starting points but nonetheless cannot sugarcoat it uk borrowing costs are higher we've got more of an inflation problem than a lot of other developed market economies we've got this piddly little bond market that's just not on the same scale as as certainly as the us and also if you're in europe if you're in the eurozone then you enjoy like the a sort of safety net from a like an
alphabet soup of rescue programs that are out there at the European Central Bank that it can kick in for pretty much whatever reason it wants pretty much well you know whenever it wants if one national bond market goes haywire in Europe they can just hose that down so there's a safety in numbers thing there basically Maybe that's a bit of a simplification. They've got backup.
You know, they've got some issues, but they've got backup and it's just different.
The European Central Bank is willing to kind of step in in the event that the spreads between all of the European bonds start diverging too much. That's critical to maintaining a single currency area. We have a central bank that is willing to backstop the market when there's a sort of systemic risk to financial stability, as happened in September 2022.
But that was to do with the business models and the balance sheets of particular sectors in the economy, like pension funds and insurance companies.
Have we hired someone who knows what he's talking about, Katie? I thought we had a rule about this.
What?
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Chapter 3: What challenges does the UK bond market face compared to others?
It can get away with stuff basically that no one else can. So if the Brits try and be all American, then we get absolutely flayed for it. As we were saying right at the top, the real problem with what's going on with gilts at the moment is that everything is really under the cosh. So even Japanese 30-year bond yields are getting close to 4%.
The US just earlier this week had to issue, was it 10-year debt, Rob, or 30-year debt?
30-year debt. Over a 5% yield. For the first time in decades, it's a 5% yielding piece of paper from the United States government. This is a big moment.
Robert Armstrong, tell us why this is happening.
Well, I think it's global to a certain degree. I think there are global concerns about
inflation and probably even more than that there are global concerns about fiscal responsibility on the part of the you know the developed world's governments right so we want more we want more yield because we want more inflation insurance but more importantly than that the developed world is more and more indebted so it's worse and worse the credit And so you need a little bit more.
Yeah. So things that bonds hate include inflation and they hate having loads and loads of bonds. You know, it's just a supply and demand thing, right? If you have loads of bonds flooding the market, then the value of those things goes down.
What we're looking at partly as a result of what's going on in Iran is inflation and loads and loads of new bonds to help governments pay for defence and a green energy transition and all of that sort of stuff. So it's just a combination of stuff that bond investors really have.
And, like, so just earlier this week, there was some nasty inflation data out of the States, right, Rob, that you had PPI inflation. It's that wholesale inflation sometimes called factory gate inflation.
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Chapter 4: Why is the UK government bond market experiencing volatility?
Do you think this is all going to get a lot worse before it gets better? Or do you think this is a bit of flim flam but nothing?
I think it could get worse before it gets better. I think one of the risks here is that there could be a challenge to Sir Keir Starmer, the prime minister. And depending on who comes out tops in that contest for the leadership of the Labour Party. There could be a swing or a lurch to the left. That means slightly more spending, more social commitments.
And it's just not clear that the bond market really wants to absorb all that additional borrowing. So there's a real question there around whether the bond market is going to kind of reimpose discipline on whoever comes into power if Keir Starmer leaves.
And in fact, there was a column in the FT yesterday arguing that you could actually be long on gilts because the bond market generally has a way of imposing discipline and constraints on governments that get a bit too out of hand.
I think like a lot of sort of, you know, Brit investors who I speak to are like, yeah, you know, this is a pretty bad situation. People outside the UK are like, oh God, you Brits will figure it out. You always figure it out. Like, I don't know. I don't know how you're going to make this work, but you're going to make it work. You're not going to do another like Liz Trust thing end of 2022.
You're not going to like throw a grenade at your national bond market because you saw that ended quite badly last time. So let's not do that again. But like...
Basically, my view. I think we're just adjusting to a new world of permanently higher debt levels and aging demographics and... We will find some way to accommodate this additional supply, whether that's central banks buying it or cutting social spending.
Or deciding you're okay with the 3% world or whatever the number is. That's the way you make debts lighter is you tolerate a bit more inflation over time and the debts automatically lighten over time.
Yeah, very few advanced economies have gotten back to their 2% inflation targets since the energy spike in 2022. And so the question is whether they even have 2% inflation targets anymore. Are they able to meet them over the medium term or not?
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