The Great Bond Car Wreck — in Slow Motion

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On Apple, Spotify, YouTube or wherever you get your podcasts. Bloomberg Audio Studios. Podcasts, radio, news. I'm Stephanie Flanagan, head of government and economics at Bloomberg and this is Trump and economics. Well, this week I'm sorry, but we need to talk about bonds, government bonds because investors have turned against them in a big way in the major developed economies in the past week, in what's been called a slow-motion car wreck that could affect us all. Especially anyone looking to take a loan out or refinance their house. Now, remember that a sovereign bond is an IOU that a government sells to investors when it hasn't raised enough money in taxes to pay for all their spending, which these days is all the time. There's a lot that affects the price of that debt, but broadly, when investors are keen, the value of the IOU goes up and the yield, the interest rate the government has to pay goes down. That happened for many years after the global financial crisis, governments found borrowing cheaper and cheaper, but yields have been rising often on since COVID, and last week, yields went up everywhere all at once in a way that made even the more grey-haired Bloomberg types pay attention. We're recording this on Tuesday morning, US time, and the yield, the interest rate on the very long-term 30-year US treasury, has just risen to its highest level since the eve of the global financial crisis in 2007. And it's not just the US, in Japan, in the UK, for example. The 30-year yield is the highest it's been this century. Now, this matters, obviously, for governments. Funding costs, taken together the past week, could mean tens of billions in interest payments by governments that could otherwise have been spent on other things. But it also matters for markets as a whole, because of what it might tell us about the impact of the war in Iran on the global economy, the future rate of inflation, and also what it might tell us about the basic standing of the so-called advanced economies. Because you can't help noticing many emerging market governments have not seen investors running for the hills in the past week. In fact, many of their currencies have been going up. Well, there's so much to discuss, and my two guests have already written some excellent commentary on it that I thought was worth sharing on the show. Robin Brooks, a senior fellow now at the Brookings Institution, was formerly chief economist at the Institute for International Finance and chief FX strategist at Goldman Sachs. He writes a lot of good stuff on his sub-stack, but one piece this week entitled, Liz Truss, Bonn Market Blow-ups, particularly caught my eye. Robin, thanks very much, waking up early on the West Coast for us. Thanks for having me on. And John Orthers, a senior editor for markets and Bloomberg opinion columnist, Long Time Financial Times journalist. Welcome back to the show, John. Thanks for having me. I did steal in my quote earlier, I stole the title of your column today, The Great Bond Car-Rech in Slow Motion. Without going into everything all at once briefly, are we right to be taking the last week pretty seriously? What's going on in Bonn Market? Yes, you should always take what's going on in the Treasury market very seriously, indeed, because it ultimately is the closest approach. We have to a risk-free rate. Yes, there's no such thing as a risk-free rate, but for any number of different financial calculations, the closest approach to it, the one that is assumed to be the risk-free rate is the 10-year approach for a yield. So it's a base for everything else. It's a base that finds its way into an awful lot of financial calculations that you would not connect in any way intuitively to the Treasury market. So it's a very big deal, obviously, primarily for US mortgages for the US companies trying to raise finance, but Uncle Sam trying to finance itself. I think the other point to make is that there may perhaps agree to more important meaning when global Bonn markets move together. So there are very specific local factors in Japan with Sanaita Keichi, with France, with the great difficulties there that Macron is having with the legislature there, with the UK and all the Russians at the top of the Labour Party. There are certainly clear, different ideas and critic things going on in all of those countries, but it still has reposited out that it's difficult to put a chart to tell the difference between their Bonn market. They have all started surging on yields and started surging upwards at the same time, and that is ultimately because of uniform concerns about fiscal space and about inflation. Robin, I did see a nice kind of quote in one of the many Bloomberg pieces about this, because the developed world has too much debt, too little fiscal discipline and no political appetite for fixing either. Do you think that's been driving the last week and why has it happened so quickly in such a short time? Well, I think that's the key question, Stephanie, and let me just add to what John said, the three points. The first is that COVID saw fiscal stimulus globally of a magnitude and a global coordination that we've never really seen before. I remember talking to a policy maker at the time, and they said, you know, we don't know what the long-term consequences of this are going to be. So many countries issuing so much debt simultaneously. And I think part of what we're seeing in recent months, including this week, is the bill is coming due for that. The second thing is that the decade before COVID, we were all convinced that inflation would be low forever, that interest rates would be low forever. We were all telling ourselves that we were in a new paradigm and output gaps were big. And so that meant you could issue lots of debt without interest rates going up very much. And that caused governments to run deficits that even after COVID, even with COVID long gone, are way wider than they were before. So if you look at the US government, the deficits running around 6% of GDP, other governments are running deficits, they're way wider before COVID. So not only did we do a huge debt issuance binge during COVID, but we continue to run really loose fiscal policy. And then the third thing is that inflation, which we thought was always going to be low, has turned out to not always be low. We had the post COVID inflation surge. And now we have a run on oil prices and what that means for inflation. So I think Stephanie, to come back to your question, all of what's going on in debt markets has been brewing for many years, long term interest rates, which in particular capture risk premium and expectations among investors for what governments might do. And of course, the big bugbearers that governments will be tempted to inflate away debt, right, to print money to lean on central banks to make debt go away. I think all these fears have been coming to ahead over the past year. And it's not a surprise that in connection with that, we've seen the debatement trades. So precious metals go through the world. We've got to expect the debatement trade for those who might get panicked even more by hearing that people buying any kind of safe haven asset that will protect them from governments inflating away debt. So that is gold, silver, platinum, palladium, you name it, but it's also currencies and debt of countries with very low debt levels. So for example, Switzerland is kind of the scenic one on, but Sweden, all the scandes are part of that too. You make the point, John, I was struggling with last week actually because in the UK, obviously, there was a lot of noise coming out of Westminster. And in Britain, we night nothing better than to say that we're in the worst possible state, relative to everybody else and everyone wanted to look at the bonds and say the reason why yields have gone up so much is because this government is terrible and this government is a mess. And I found myself in a rather difficult position saying, well, this is that is true, but actually there's a lot going on. And in fact, the biggest factor that's increased the cost of government was these other things going on. And as you say, you can't necessarily tell the difference between their political crisis and the things going on in the US. But we've just been talking about long term things, structural things affecting the way that investors would look at bond yields. So you still might say, okay, but Why has it all happened in the last week? I mean, is it sort of people suddenly realizing that the strength of hormones is going to be shut for a long time? Because they can't be suddenly realizing that governments don't want to cut borrowing. There is, I mean, the Malcolm Gladwell got rich with this infuriating concept of the tipping point without ever explaining exactly when or why a tipping point will happen. There are such things as tipping points playing this happens in markets when some kind of a weird psychological turn or some point in mass psychology is reached and things start to move very fast. It would be ridiculous to say this is all about the straight-up hormones. However, plainly, that's the trigger at the moment. If you want to talk in the short term about why, particularly this was a trigger, my best guess is that there was some hope out of Beijing last week that there would be some pressure from China on Iran to reopen the straight. And it didn't happen evidently. And if you look at prices for Brent crisis, for December, they continue to reach a new high for the crisis. We're now above $90 for Brent at the end of the year. That is followed by people in bond markets. They are being told by the oil market that, yes, this isn't a transitory thing. This is going to last for a while and therefore, the risks for creating an inflationary impulse have risen. Ultimately, again, it's an irritating, glad, well, it's happened to happen last week. If you wanted a specific moment last week that helped things run, maybe let's try to make ourselves feel important as Brits. Maybe the guilt's market helps. But the main thing is oil, if we really expecting crude to be above $90 by the end of this year, which we weren't even a few weeks ago, that does come a point where you just have to act on that. We tend to say as economists, well, if you have these long-term structural changes and in fact, our economists, you think that there's a long-term increase in interest rates in the neutral real interest rate globally from lots of big tectonic forces. But you tend to say that's manageable if it happens over time slowly, a big increase like we've seen in the last week. And certainly, the big increase in borrowing costs we've had since the start of the Iran crisis. Then you start to worry, US treasuries, are the kind of central common denominator for the whole global financial system. And there have been worries at various times in recent past about the short-term liquidity in those enormous markets that you would have thought would never happen. Are you nervous about unexploded grenades that could go off just from this move having happened so fast? Yeah, if you remember back to long-term capital management or particularly to 2007, 2008, you always have to be concerned about that. I think it was Robin's piece covered some of our own analytics of Bloomberg that-- I mean, Japan and the UK, you can see some signs of stress, but still nothing like the very serious financial accident that happened with Liz Truss. There's no really clear sign of stress trading here, particularly here in the US, obviously, if there was that would be a reason for very great concern. This looks more even if we've reached some kind of a tipping point more like a healthy-- as far as it goes-- a healthy adjustment, a healthy realization. Then the concern obviously has to come into other markets. Are they really going to deal with what the bond market is telling them, which so far, they, in many cases, are not? The other thing is if you live through 2007, 2008, you can get into this thing of what's not as bad as that. So it's fine. It's true. We have too many terrible things to compare it to. Yes. It's not in that territory at all. But it ought to be healthy. There is no clear sign of really dangerous instability or liquidity to this state. Well, John, you're not a central banker, but I suspect we could, in a few weeks time, depending on what happens, we can come back to you with healthy the way people came back to J-Powell with transitory. Robin, I quoted your sub-stack about the Liz Truss bond market blowups. And I think when people hear that phrase, they will think, oh, he's talking about great drama and crazy politicians doing things. But actually, you made a specific point that actually relates to this healthiness thing. Because what we might call in a developed economy, a healthy adjustment in bond markets wouldn't usually come with a fall in the currencies. That was the thing that you'd highlighted. And I just wanted to dig into that a bit. In the G10, so in advanced economies, typically higher yields mean a stronger currency, right? It increases the yield that you get on holding that currency. So it is very unusual to see yield spike and the currency fall. That is kind of what happens in emerging markets. And it is a symptom usually of policy credibility being relatively low. So that when you have a shock, people aren't confident that the policy framework is stable. And so they are worried about central bank credibility being undermined, the central bank being pushed into printing money, and therefore a loss of value across the board. And so they bail on the country. They sell all assets. And so the currency falls in addition to government bond prices falling and yields going up. The biggest example of this that we've had in the G10, or I should say, the most volatile and kind of the loudest was the UK in the LDI blow up in 2022. In September and October. But the thing is we're seeing more and more of these instances across the G10. And I think that's symptomatic of us converging in the G10 down to EM. And of course that also means EM converging up to the G10. And another example of a similar blow up is the US in April 2025 when Trump rolled out reciprocal tariffs. And everyone was wondering what was going on. The dollar fell as yields spiked. That was a very scary episode. And as you know, the US Treasury market has major vulnerabilities because of the basis trade and the swap spread trade. Those are high pockets of leverage, which wobbled at the time. And then the thing that I highlight in my sub-stack piece is Japan. Japan is the mother of all of this has been in a Liz Trust style sell-off for two years. It's crazy. And it doesn't really get the attention that it should. But yields, especially the long end, have been rising continuously. In any G10 currency setting, you would think that that would boost the EM. But the EM has been falling. And it is really, really worrying. And it basically, to me, says, if I think about what should the yield for Japan be, then with gross debt of 240% of GDP, basically markets are saying, well, I would like a yield that's much higher. I want to be compensated for all the risks that come with such a high debt level. What we're getting is a far lower yield. And so I'm going to sell the currency. And so all the shenanigans that Japan currently is trying, and I'm referring specifically to official effects intervention-- that stuff, it just doesn't work. It's basically just signaling a government in denial. The Bloomberg this weekend podcast, news, politics, and the lighter side of Bloomberg. The great wealth transfer includes $570 billion in classic cars. I'm not in the position to be inheriting any classic cars for you. No, but my brother didn't inherit my non-classic car when I moved to New York. So-- He still has not paid me for it. Coming for you, Joey. The Bloomberg this weekend podcast, subscribe today on Apple, Spotify, or wherever you listen. Robin, the way you sort of particularly crossed my radar when I was sort of first involved in this world was as Chief Economist, the Institute of International Finance. That's the institution that sort of has particularly gathers a lot of good information on what's going on with investment flows across the world. And I just wonder, as someone who sat for a long time looking at both emerging market economies and the big G10 economies, are we getting to the point that-- or at least the trends that you're talking about? Does that mean that you're going to start not being able to tell the difference? If you're not given the name of a country, and you look at their bond market, their currency dynamics, that you're going to start not being able to tell the difference between them. Are we already at that point? We're already well on the way to that. If you think of Eastern European economies, some of which are now in the EU, back in the '90s, they were considered emerging markets. I think they, on most metrics, these days, start past some of the older members of the EU, in terms of their fundamentals and debt levels. But let me give you a concrete example of an emerging market. that really stood out positively after COVID. G10 central banks were trapped in kind of this pre-pandemic think bubble, which was inflation will always be low. And so they dismissed the inflation surge that happened after COVID. And then you look at a central bank in Brazil, which basically said, yeah, no, we're going to hike. And they hiked early and much quicker than G10 central banks. So we are seeing a shift. Of course, it's been a long time coming, as you say. And I think emerging markets, if you look at their currencies against the dollar, one of the things that I've been highlighting is that emerging market currencies are on a big trend appreciation against the US dollar. And that's really about convergence of EM, central bank, and other policy making decision making and credibility to the G10. It does make me think, John, we tend to talk about the US having an exorbitant privilege because of its dollar status. And obviously that's still the case in many ways. But in a way, these G10 economies have been trading on a kind of exorbitant privilege that somehow they felt they could get away with having these very high debt levels. And they could do everything that emerging market economies do, but somehow because they were, you know, developed and advanced and they'd been around for a long time, they could get away with it. And people would specifically point to Japan as the example of that. Well, they still don't have to pay very much to borrow despite having these, you know, extraordinarily high debt rates. I mean, is that just now very rapidly going into the past? Yes, it is, but there are still some very important market effects of that dawning realization. The one way to measure this that I think is fascinating is the carry trade, which for the uninitiated is a very popular way of playing the foreign exchange markets where you borrow from a currency that has a low rate, such as most obviously the yen and market in a currency with a much higher where you can get much higher rates, such as at the moment, the Mexican peso. And you pocket the difference between those two interest rates known as the carry. And providing there isn't a sudden turn in the interest rate in the exchange rates against you make money. The Japanese yen Mexican peso carry trade has made a higher total return in this decade than the S&P 500. All it is is just leveraging the fact that Mexico knows it's got a problem with inflation and will hike rates as soon as it sees there's a risk of inflation rising because it's an emerging market that's been hit several times in living memory by terrible financial crises because of this. While Japan is a country where he needs to be about 60 years old to remember there being any problem with inflation at all and behave differently and you can simply make that kind of that kind of money. You can do better than buying the US stock market just by leveraging that difference. Now that that cannot go on much longer, it seems to me. So you mentioned the equity market and I did want to ask you maybe this is sort of the last bit of our conversation, but you know anyone listening to this would think, wow the world's quite scary place. I mean not only have we got the obvious Iran war, but actually the market's telling us that inflation is going to stay higher that the government's credibility across the advanced economies, the economies that still play a enormous role in the global economy, their credibility is shot. They're not able to convince investors that they're really going to do the difficult things to reduce their deficits and we know that the voters in those countries don't want to do anything, don't want to face up to that reality particularly. But despite all of those long-term fears that are supposedly represented embodied in this big increase in the cost of borrowing for governments, the equity markets don't seem to have really noticed or cared. How does that work? To be fair to equity markets, as many of my readers kindly point out that I have a strong tendency to be incorrectly bearish about stock markets. So to be fair to stock markets, there is something genuinely exciting happening in the earnings that are being generated by companies building out the AI and the earnings that are being generated by semiconductors in particular recently have certainly been that that would always give you a reason in any pulse to buy stocks. That's what you buy when you buy a stock of the future cash flow from their future earnings. That's yeah, I agree. It seems to me. They ought to care a bit more. Well, the classic Alan Greenspan rule of thumb was to compare the earnings yields. The inverse of the P, the earnings per share, as a proportion of the share price with the 10-year treasure yield, with the general idea being that when you can get a better yield from bonds, where the only risk you're taking is that Uncle Sam doesn't repay you, then on stocks. That probably means stocks are a bad deal. At the moment, the gap in favor of bonds is its widest since 2002. And it's not having any effect thus far on enthusiasm for stocks, because there are good reasons there are at least two huge shocks going on at the moment, but oil and with the AI and the semiconductor trades, but all other things equal, you would think a move like this in the bond market would be a serious problem. I just want to add something, which is that equity markets can be forgiven for thinking that governments will put central banks under pressure to intervene if things get really bad. Think back to COVID in March 2020. I think the Fed in the space of two months bought one and a half trillion dollars worth of treasuries when the treasury market was going crazy and yields were spiking during the pandemic. In the summer of 2022, the ECB intervened to capital and Spanish yields and introduced new tools to keep those yields down. So there's a lot of intervention in government bond markets. What we see is kind of a parallel universe. But if you're trying to sort of balance the optimism in the equity markets, some of which is based on a lot of which is based on potentially quite sort of real positive developments in the real economy from AI. But also this loss of credibility, potential challenges for governments and governments financing. I mean, you'd have to at least conclude that we're going to have more inflation than we have because that's the even the kind of intervention you're talking about Robin eventually means a bit more inflation because you've effectively got some government central banks kind of buying up debt, which is pretty close to monetary finance. John, it does seem like a bit more inflation than we might have expected. If we add up all the things that Donald Trump is doing, all of the things we've been talking about on this program, that seems a fairly safe bet, doesn't it? Yes. And we came into the year expecting several Fed funds rate cuts that has an effect because it's highly difficult to see how we're going to get them any longer, any shift like batting expectations for talking in the short term. But in the longer term, there's all these, any number of demographic reasons to think that inflation will return this effective life. But in the short term, yes, there has been a clear turn and people who were expecting rates cuts and not to go to get them, that will have a fair, fair benefit. All right. Well, we will see how it plays out in a sort of Trumponomic world and more generally. But I'm glad I started with a bit of explainer at the beginning because this has been a bit more technical on the market front than we usually are. But I think everyone will have stayed with us thanks to you to Robin and John. Thank you very much. Thank you. Thanks for having us. Thanks for listening to Trumponomics from Bloomberg. It was hosted by me, Stephanie Flanders. I was joined by Robin Brooks, a senior fellow at the Brookings Institution and John author, senior editor and columnist for markets at Bloomberg. Trumponomics was produced by Samasadi and Moses Andam with help from Amy Keane. And Soundes Island was by Blake Maple's and Kelly Gary. To help others find us and enjoy the learn from Trumponomics, please rate and review it highly wherever you listen. [Music] [Music]