Analysis-Bond Vigilantes Mean Business, Governments Better Beware


By Marc Jones and Yoruk Bahceli

LONDON (Reuters) – The sight of Britain’s new finance minister destroying his leader’s economic policies on Monday illustrated something very clearly – the bond market vigilantes are back, they are bold and governments should be careful.

It took only three weeks for the markets to force the United Kingdom, the world’s sixth largest economy and issuer of one of its reserve currencies, to do an about face.

Trying to cut taxes when there were already big holes in the national finances had caused UK borrowing costs to rise sharply, forcing the Bank of England to step in and former finance minister Kwasi Kwarteng to lose his job.

Even after Monday’s reversal, the damage to UK government bonds or gilts remains. Ten-year gilt yields are still around 46 basis points higher than where they were before the Sept. 23 mini-budget, 30-year yields are around 55 basis points higher and mortgage rates remain significantly more expensive.

“Now is really not the right time to experiment with fiscal policy,” AXA chief economist Gilles Moec said of the UK’s moves, saying Monday’s U-turn could have appeased “the bond vigilantes for now”.

The term “bond vigilantes” refers to bond investors who impose fiscal discipline on profligate governments by forcing their borrowing costs higher.

In another sign that Finance Minister Jeremy Hunt was trying to restore his credibility, he announced a new Economic Advisory Council made up of four finance experts: Rupert Harrison, former chief of staff to former Finance Minister George Osborne who works now for BlackRock, former BoE member Sushil Wadhwani, another former BoE official Gertjan Vlieghe now at New York-based hedge fund Element Capital and JPMorgan strategist Karen Ward.

The surge in gilt yields has been more severe than for comparable German or US bonds, but seasoned economists point out that London is not alone in the crosshairs.

Indeed, interest rates are rising globally and central banks are no longer running the bond-buying programs that have long tied up government borrowing costs.

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

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

Ed Yardeni, who coined the term bond vigilantes in the early 1980s, wrote a blog post saying “They’re Baaaack!” when havoc in the UK first broke out last month.

He thinks the spike in US mortgage rates this year to their highest level since 2008 is another potential problem and that heavily indebted Italy could be a target if Europe suffers a widespread energy crisis this winter.

“Central banks have controlled Bond Vigilantes with ZIRP, NIRP and QE,” Yardeni said, referring to the post-financial crisis years of ultra-low interest rates and stimulus. “No more: they are back in the saddle and riding high”.


Many European governments are torn between the need to protect households and businesses from the energy shock as Russia cuts gas supplies and the need to tackle record inflation and maintain fiscal sustainability.

Italy has long been a source of concern due to its huge public debt of around 150% of GDP and slow economic growth.

A victory for right-wing parties in national elections in September also stoked fears after campaigning for higher pensions, social benefits and a 15% flat tax for the self-employed, without saying how to fund it.

Hungary also showed that emerging markets are always at the mercy of the markets.

Its central bank was forced to raise some of its interest rates to as much as 25% on Friday after its attempt a week earlier to try to end its rate hike cycle, sending the forint into another free fall. .


Yet the crisis triggered by Britain’s mini-budget has caused global dismay.

Even US President Joe Biden was speaking the language of the bond vigilante over the weekend, noting he was not alone in thinking the UK plan was a “mistake”.

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

Germany’s program focused on energy support and was likely to span a longer period, analysts said, explaining why Germany’s borrowing plans did not trigger unease on the market like the British September plan did.

“This is probably the greatest example in practice of the activity of bond vigilantes,” said Antonio Cavarero, chief investment officer at Generali Insurance Asset Management. “If it can happen to the UK, it can happen to any other economy.”

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


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