Open Editor's Digest for free
Roula Khalaf, Editor of the FT, selects her favorite stories for this weekly newsletter.
When bond markets get sticky, it's no use being the worst horse in the glue factory. Unfortunately, that is the role the UK is currently playing.
It's been a bad start to the year for global bonds, but again contrary to what the right analysts and professional investors are telling us to expect in 2025. From the US to Japan, and pretty much everywhere in between, the market economy has developed. bond prices have fallen, pushing yields and borrowing costs higher – a blow to countries going cap-in-hand with investors looking for funding.
The UK, however, has the unfortunate distinction of suffering more than most, and given the recent memory of the 2022 gilts crisis, alarm bells are ringing. A new twist to the story emerged this week, when the mercifully short-lived prime minister, Liz Truss, announced through her lawyers that it was unethical to advise her to freeze the economy at the time. This is an interesting move, and shows some ignorance The Streisand Effect.
In any case, the pressing question is whether we are at the beginning of something new gilts a big fire. The short answer, in my mind, is no. The long answer is: it is largely out of the hands of UK policy makers.
To be clear, the collapse of gilts this week is a difficult episode. Not all, but many investors have been chilling on UK debt for some time, suffering from signs of persistent inflation that will prompt the Bank of England to keep cutting interest rates. Ten-year yields have risen by around half a percentage point since the new government's Budget at the end of October. That's a good amount for the bond market, which represents the biggest fall in prices and includes a sizeable drop at the opening of this week to take long-term yields to their highest since 1998.
More surprisingly, perhaps, sterling has hit again, suggesting that this is not just a case of investors reassessing their view of what the BoE will do next and when, but a shift away from UK risk in general. (Even the share price of Gregg's has taken a hit, and if you can't bet on Brits getting pennies and sausage rolls, there's really something wrong.)
Declaring the gilts shake-out as a new crisis fits the political agenda of some observers. But the context here is important. Overall, stocks are up in the young year to date, not down, reflecting the strong relationship between the FTSE 100 index, which is heavily weighted by overseas earnings, and the weak pound. The same was not true in 2022, when the FTSE went bankrupt. Yes, the halving in 10-year gilt yields is the most since the Budget. But in 2022, they jump over that in three days. These two things are not the same. And the pound is weak, sure, but so is the euro, the yen, and everything else except the strong dollar.
That's the key here. The real story is the global rise in bond yields as the US economy keeps bulldozing ahead of other developed countries and inflation remains above target. In mid-December, i Federal Reserve indicated it would not be as quick to reduce prices as investors previously thought. In the past few weeks, markets have expressed expectations that the Fed would cut interest rates several times in the opening months of this year. Now we're looking at a summer chop, maybe, and maybe one later. Friday's surprisingly strong US jobs data added more fuel here.
U.S. bond yields, which exercise the biggest drag on global debt markets, are rising, too. Benchmark 10-year US yields have gained almost 0.2 percentage points so far this year, and that's throwing the entire market out of whack. The UK is in the crosshairs because weak gilts are boxing chancellor Rachel Reeves into an uncomfortable position where she may have to cut spending or raise taxes. But yields in fiscally austere Germany have risen by the same rate as in the UK without much controversy.
Despite the sluggish US economy, global pressure on bonds comes from what Nobel Prize-winning economist Paul Krugman described this week as “Crazy charge” on bond yields in the US.
A rise in long-term rates, such as the 10-year Treasury rate, may reflect a nagging, nagging suspicion that Donald Trump really believes the crazy things he says about economic policy and will act on those beliefs, Krugman said in his blog. Point to higher trade tariffs, tax cuts and mass deportations that could lead to renewed US inflation.
So what prevents decay? My mind freezes. US bonds will no longer slide in value when they begin to represent an inevitable sell-off for investors. This is possible if and when 10-year yields approach 5 percent, up from nearly 4.8 now. The same is true of the UK, which for all its woes, has rarely defaulted on its debt. Large round numbers, in this case five, have a strong tendency to drive home this message.
But the dismal showing in bond trading standards this week, for Reeves and the rest of us, is a reminder that the US is driving the car in developed markets. We are just passengers and we have to trust that it will drive carefully.