The great global bond sell-off – causes, consequences and what comes next

It's Friday the 21st of August and this is your capital economics weekly briefing. I'm David Wilder and this is a special episode all about what on earth is happening in bond markets. We've been inundated with client questions about why long dated bonds have been selling off and not just US treasuries about whether we're seeing another global crisis, about what governments can do about it and of course more immediately about US Treasury Secretary Scott Besson's latest market intervention. We addressed all of these questions and more in a drop-in which is one of our short form online briefings on Thursday and to timestamp that it was held at 10 a.m. New York 3 o'clock London and we thought this week it was worth sharing an edited extract of that session. In this extract you're going to hear Neil Shearing, our Group Chief Economist and Chief Markets Economist Jonas Gultaman. We hold regular online briefings like these each week on global macro and market developments. If you're not already a subscriber to our services you can start a free trial now from our website capitaleconomics.com. Anyway here's that extract now it starts with Jonas updating us on the latest moves in bond yields. We had a bit of a reprieve over past couple of days but it looks like the long end yields are showing that off and rising again towards although not quite all the way to the levels we saw at the end of last week which of course it's a striking thing in the US 30 years at the highest level since 2007 at similar in the UK and Japan August and Japan it's even longer than 2007 and the Eurozone long end yields since early 2011 for the Eurozone crisis really kicked off so it's symbolic more than anything the pace of this increase. It's pretty rapid but it's not exceptionally rapid. We're still well short of crisis territory like we saw in say the autumn of 2022 or 2023 or all the kind of selloffs that we saw earlier this year in March when the US are on or started or last April after liberation day. So overall it's worrying but it's not panic situations quite yet. I do want to drill down into what caused that reprieve however temporarily but I just want to pull the camera back a bit because I want to make the point this is very much a global story isn't it Neil. To what extent there is this is what we're seeing in advanced economy bond markets global and to what extent are there the idiosyncratic factors at work here. As ever with these things it's a bit of both I'm afraid the risk of giving you an economist answer. I mean it although the headlines have focused for understandable reasons on Japan and the US actually this setup has been pretty global in nature. Japan's a little different I'll get to Japan but if you look at what's been happening in the US market if you look at what's been happening. UK Gill market in French government bond market a tanning government bond market. We've seen yields rise kind of across the curve the particular the back end of the curve in those countries. Japan's a bit different because we're seeing yield rise across the curve and we can get into reasons why that might be the case. And so that leaves only relatively a small number of countries that are the government bond markets that are not being so much affected by the sell off and typically this gives you a hint of what we're dragging the sell off. They're the ones where we're governments have stronger energy so Canada Sweden Switzerland yields a burning budge. They're they're safe havens as such in this sell off not very deep liquid markets either. So it's not just the US is not just Japan slightly idiosyncratic things happening in different countries but it's pretty global in nature itself. Someones ask I mean they made the point about higher interest expenses worsening demographic pictures increased demands for defense many higher defense spending and then on sort of sort of on the demand side. Perhaps some sort of structural weakening there that we can get into but their fundamental question is are we seeing the sustainability of debt in these economies being fundamentally tested. I think we are frankly and this is something that we've been warning about for a while now I don't want that to suggest don't need to suggest by that that we're heading for some kind of imminent fiscal crisis or bond market crisis and that's not what I'm saying but we were warning as far back as two years ago. The fiscal risk we're building quite a substantial way across developed markets that economies were not back at full employment after the pandemic in yet but it deficits were still extremely large debt burdens large and of course the big shift that's happened over the past two or three years is that we've gone through a world in which certainly post GFC through to the pandemic real interest rates were negative neither not so negative and in the many cases positive so. So you've got these conference of factors economies return into for employment deficits still large real interest rates no longer negative then you overlay on top of that a series of stack facing shots on the supply side of economies that's a pretty toxic mix for for bond markets I don't think we're necessarily in fiscal crisis territory yet but it does I think to my mind that these underscores the unsustainability of fiscal trajectories in a number of countries which economies this is another question. Lots of people have been asking which economies do we see the greatest risk of a fiscal crises within the first point to say here is a really good question and there's one that we get all the time but I think the first point to say is that there's no kind of magic number or magic threshold for what constitutes physical sustainability with different things different economies. If you look through the broad sweep of time you've had suffering that crises will be in emerging economies when government debt to GDP is ridiculous 15% of GDP but that's because of the characteristics of that debt lots of fall currency debt in the system. And then the currency paid breaks and you get a fiscal crisis and the other end of the spectrum we've had Japan with where the gross government debt burden has been in excess to 200% of GDP net of government debt while above 100% of GDP for decades and yet nothing has broken so there's no magic number I think is wrong to say that you go past this threshold there's a crisis. And instead is often is the perception of sustainability that matters and that's what I think makes this set off so dangerous that the bond markets seem to be sniffing that some things don't quite sustainable the rule on the wrong footie here and then things can unravel and go away from government pretty quickly. And to answer your question those to which countries are most vulnerable there's four that stand back to my mind in the benefits economies they are not Japan actually despite the high debt burden there very high domestic savings rate quite difficult to see a fiscal crisis emerging in that country against such a backdrop of a high savings rate. And in fact the numbers we're improving there instead is the US its France is Italy and it's the UK if you're thinking about triggers will be beyond this kind of wobbling the bond market then he might have got a reprieve from Secretary Bessons bond market may have got a reprieve from Secretary Bessons over the past 24 hours but we've got elections coming up in both France and Italy next year I think they could be kind of another trigger points for for stressing the bond markets if they go the wrong way. I do want to get on to the intervention by the US treasury Jonas but before I do can you just just get on to the sort of the mechanics of the rise in yields with all the deals just said there. The move up that we've seen at the long end in yields lots people ask if you break that down for us what exactly has been driving up yields was a good question and it's one of those were there isn't really an obvious. Trigger in terms of events or news that would have has led to this move with past few weeks I mean the news out of the Middle East has been a bit worse energy prices have cracked up a bit that doesn't certainly doesn't explain all of this. Any you've had you know that there hasn't been political news in in the US or Europe must your parents are on holiday anyway so a number of bond investors which maybe part of why it's happening so that doesn't help either you know it's been some always out of Japan but it's hard to know what to make up. And there's the old mentioned that the move there is actually a bit different in character than what's seen in your US and Europe so it's hard to sort of put your finger on well this is what's wrong. If you had to pick one thing it is probably the post FWMC press conference that the new chair Kevin Worsh gave three weeks ago now which was not well received certainly by the long end of the treasury market which I think sort of revived this sort of concern that the US that the current sort of US policy making. It's all going in a different direction and introducing new new ways of doing things which the bond market doesn't necessarily love market center for stability and certainty over change even if that change isn't necessarily your conceived it's just in this case not fully communicated at this point and I think that sense intervention kind of along with the currency intervention that they did a couple weeks ago. That's the sense of well I'm not sure what you're trying to do here but clearly you're worried about the long end of the bond market and since you're in charge of all this you must know more than I do and if you're worried I mean I was already worried but now I'm worried and the fact is you know as you're saying it takes that back you know you maybe it may be surprising in some sense that this is move has happened without a trigger but the backdrop is fiscal deficits are necessarily high certainly in the US but elsewhere as well. [BLANK_AUDIO] levels are very high and the bond market, you know, is sort of, uh, the seams are tearing up it. So in that sense, it's not surprising at all that yields are this high. I think to just to build on that into that point, we get a lot of questions by the extent to which the large net issuance from the hyperscalers and other tech companies, uh, has added to kind of debt stress and debt concerns and clearly at the margin, I think that has been in the case. But it still feels to me that that's a relatively small part of the story. We might have a different take Jonas, but you just look at the sheer numbers involved net issuance by the US Treasury this year's going to be something like at least double, but probably three times the size of non-financial corporate debt issuance. And if you look at the outstanding stock of debt, many, many times higher. So 24 trillion of outstanding, long dated Treasury debt versus a trillion of non-financial corporate debt in the US. So I think it's one of those situations where you get a kind of big move in markets and everyone reaches for a kind of explanation, everything gets kind of thrown in that. But I think a route, this is a fiscal program and a manifestation of fiscal strains that has not been helped by large net issuance by some of the hyperscalers and tech companies, but definitely that's the cause. Yeah. I mean, a couple of points to add to that. I mean, the issuance by these companies is pretty striking and it's up from basically they used to be not issue much to have to dole and the hyperscalers just those five companies issued about $200 billion for corporate debt the past year or so. And it's in some sense is more than that because they used to be net saviors. They used to all the cash, you know, all the profits that were making were converted into say cash savings for the most part that they paid some dividends, but not much. And so in some sense, they were actually helping to fund the US Treasury so that sort of net swing is over the past two, three years is quite dramatic as they've pushed this AI infrastructure build out. And I guess the other point about that is that well, if you think what in about why our interest rates higher, but well, it makes sense you have an investment being ongoing. That's pushing growth higher. All else equals that pushes up on on interest rates, both at the short and then at the long end. And in some sense, that is a positive development. No, at least in principle, it could be a positive development, which is one of the points that Mr. Walsh is stressed. And if, you know, if it leads to a sustainably higher growth rates than the economy, you know, in that sense, higher interest rates would be, you know, not a bad thing. It would just be a reflection of a positive development. So your questions come in. We had a question earlier this week. It wasn't a question or a comment that, you know, you look at yields now in a pre-2008 world that that just that's kind of just look normal, right? So what we're seeing, in to some degree, is a return to normality. And Neil, I know you referenced earlier what was going on in Japan. What would you say to people saying 5% yield were just going back to where we were? This is what the world should be. Yeah. When I think there's something to that, right? I think there's something to the idea that we shouldn't lose sight of the fact that we have spent the last probably 10 or 15 years talking about the unusually low interest rates, how distorts if they are, how that leads to misallocation to capital, and how we need to get back to more normal quote, quote unquote levels of rates and yields. And now we've got back there. And the mark is a freaking out. So I think there's an irony there. We shouldn't lose sight of the fact that you can send this reflect reflects the fact that disinflation in defacers no longer the biggest danger. The economy is a backup for an employment. That's a good thing. But the backdrop is critically different from where we were mid 2000s. Last time we had the yields of this level with regards to debt burdens. Like coming because it gets back to the point I was making before that we're at an employment. We've got large deficits. The debt burden is large. And now we've got real interest rates that are no longer negative. Now all of that was being sustained. There's debt burdens will help to help to be saved on the fact that real interest rates were negative. Now they're not. We've got the rise in the years but against this backdrop of the large debt burden. And it means that I think governments are going to have to start undertaking some fiscal consolidation to show some kind of a pass to that over the next couple of years. Otherwise things will start to get up the bomb market. So yes, to answer your question, yeah, to the extent they reflect the kind of return to a bit of normality is going to flow for employment and the retreative deflation risk to economies then is not bad. Things are a good thing. But it's coming against the backdrop of this high debt burden. And that's the concern. Jonas, we've had a few questions about just if you would just decompose if you like the rise in yields. How much is someone's asking on inflation expectations, playing any role here? Lots of questions about this idea of the term premium and how much that accounts for the rise in the yields. And then as a follow-on, obviously, where do we see the term premium going from here? Yeah, that's a good question. And I guess there's two different ways of splitting long to bond yields, but if you look at inflation compensation by the swaps or inflation bonds, that's not really the main driver. It's up a little bit over the past few weeks, but it's not the main part. Mainly it's real yields or non-inflation part of the inflation bond that is going up by more, so this brings the bulk of the move. And I think that is something that, you know, we in so many public speakers will take some comfort from because it suggests that it's not conclusive proof, but it suggests that credibility of the inflation targets that the third and other central banks have, let's say that 2%, is broadly still intact. You know, there's that longer term inflation compensation. It is a bit above 2%, but, you know, roughly in line with where it has been historically. So that's not what's blowing out. It's the real yield that's blowing out. And that points to, you know, if you think about it, the other way of splitting long term yields into risk neutral inflation, interest rate expert patients, and then a term premium on top of that to account for, you know, the residual factors, demand to fly balance and so on. And on those estimates, you know, the most timely one we get is the ACM one from some feds measure, but it's not an facial third measure. That has been creeping up over the recent weeks, and then that's just, that's one way of looking at it. You should always take time for your estimates with a pinch of salt, but it's consistent with everything else that we've seen in the bond market, you know, the curve is steepening. And, you know, to the extent that has been used, it's things that will make you more uncertain about the future of interest rates in the US. And it also goes to the point that Benio was just talking about that this is ultimately a fiscal problem, more than anything else. So that's how we see it, the term premium grouping higher, and that makes sense, you know, with the economic backdrop that we have, both fiscal policy being unsustainable, quite clearly now in the US, and also the economy is running pretty hard, and you're in the US more so than elsewhere, and that's an environment which you would expect longer term yields to be a bit higher and term premium to be on the up. You know, if you take the ACM estimate, and most other estimates are sort of the same ballpark, it's somewhere like 80 and 90 basis points at the 10-year point now, that's up from, you know, negative 50 or 100 basis points at the peak of the pandemic, and then years ahead of that. So that's quite a big swing, certainly over the past few years, but in terms of the level, again, you know, we're basically back to where in the mid 2000s, mid 90s, that period, in fact, we're a bit lower than the average of safety, 95 to 808, as the analogy, there's still another 20, 30 basis points to go to get just to get to that level, and I think that's a reasonable risk gets for where we end up. Now, on top of that, you know, I think you have to worry about term premium blowing out, sort of short episodes, like we've seen that, obviously we saw that here in the UK a few years ago, 2022, that kind of episode with a term premium just explodes, that is what you get really worried about, because that leads to broad dislocations and spillovers and so on. And you know, the risk of that kind of episode is is fairly increasing, although I don't think we're quite there yet in the US. I know there's lots of questions, David, about kind of what policymakers are going to do about this. So I don't want to hog any more time, but I think just to get about to a previous question that we had about what kind of was driving all of this. And point I made was that at times when you get these big moves and markets, everywhere has a theory, and so you end up with kind of five, six, seven different theories of what's going on. I think one of the things that we can rule out, actually, in terms of driving for the Sun, I think it's to what Jonas was just saying, is that this is about inflation concerns. Some people have said as the war in Iran, higher energy prices, concerns about wars, just how committed the war spread to going to be to a 2% inflation target, I think this set off was due to those inflation concerns that we'd see in more clearly in inflation expectations. We're not seeing that. It's coming through instead in real yields and in term premium. So yeah, it doesn't necessarily answer the question, is still exactly what's driving it, but I think we can rule one thing out, which is that it's a war of economic inflation concerns. Neil, let me ask you lots of questions coming in about this treasury intervention. What can governments do to manage or mitigate the risks, the cost that come with higher yields? I don't know if you want to call it financial repression, but just using the best and Scott Besson's intervention, this increase in buybacks as an example, is that the kind of thing we can expect going forward? Is it effective? What's your take? I would turn that a bit more, put down the kind of debt management camp rather than kind of financial repression or anything more fundamental. No, I think there are basically three buckets of things governments can do. I think it is governments, by the way. I think central banks, obviously, they can backstop the softened bond market if things get really, if you start to get some really severe dislocation and risk to financial stability, but by and large, central banks are going to step away from this and they're not really viewed as that their problem to deal with, I suspect. So it's a physical problem, as I'm saying, it's therefore up to governments to really to address. And there's three ways they can do it. There's through what I would kind of turn debt management techniques. So this is the Treasury buybacks program, the Secretary of Bathson has used over the last 24, 48 hours. You can start issuing more at the short end, less at the long end, if you get in pressure at the long end of the curve, those kinds of measures. There's financial repression, so you could just lean on commercial banks to hold more softened debt, particularly along with charities if you wanted to. You could cap me, I mean, that's what we have a regulation queue in the 1950s, much more difficult to do in an era of liberal capital flows and open capital accounts, but that's really strange for a financial repression. But I think really that none of that is any substitute for getting to groups of the really fundamental issue, which is the third issue, which is physical consolidation. That's what they've got to do. That's not to say that they need to come out today with a plan to target some physical policy tomorrow, but there has to be some acknowledgement, particularly in the US, where it needs a party wants to acknowledge the fact that there's a federal budget deficit of 6% of GDP in a time when the economy is a full employment. In a plan, what we're going to do about this, one is the pathway for bringing debt and deficits there. So you've got these three tools, you've got debt management tools, you've got financial repression type tools, and you've got physical consolidation. That's what they can do about it. What are they going to do about it? Pretty skeptical. They're going to do anything in the third camp, frankly, at this stage. And that's the absolute push. So we're into the kind of comes one and two. The moment is mainly about the management that seems to be helping a little bit at the margin. I think we wrote a piece. Again, we can link to this and send it out afterwards about financial repression and how that's going to make it come back, but how it also exists on a spectrum of policies. I think that may not be too far behind either. Jonas, very immediately, you said this, described this as a reprieve at the beginning, this, the move down in eels. Now they're creeping up again. Are we going to expect more announcements from the treasury or where does Besson's interventionism go next if this continues? Well, that's a good question. You know, he certainly has a habit of pulling various rabbits out of the hat. So I wouldn't exclude him doing something similar in the coming weeks. You just, you know, he could do more of this kind of debt management buyback stuff, but you know, in some sense, that's really just a sticking plaster re-ranging the debt pockets a little bit. They just had the quarterly refunding announcement where they announced plans for what that to issue over the next quarter, but they could conceivably revisit that or more plausibly when November comes around. And the next QRA is due that they just shift the balance further towards the short end. That's something that he has been doing for a while. Japan has done it at the UK, as well, although in those cases, they're starting from a position where there's a lot more long-term debt in the system than it's the case in the US. So the US has less space than that on that particular front. But you can see him doing that. Or he could do something, an author or something unconventional. I don't really know what, but maybe some sort of trying to get private investors to commit to buy a certain amount of long-term treasuries or maybe foreigners to commit to holding onto the ones that they have. It's something weird and wonderful among those lines. He certainly is fairly innovative as Treasury Secretary of State. He's not afraid of trying new things for better or worse. So I'm so excited to see what he has in mind. Thanks. That was Jonas Goldman and Neil Shearing on the global bond market sell off its courses and its consequences. You can watch the whole briefing on our website capitaleconomics.com where you can also find our bond forecasts and analysis, including that note on financial repression that Neil mentioned. Before I go, a small correction to last week's recording, I said our UK team is estimating that this October's budget will raise something in the order of £25billion in taxes. I meant to say that that was comparable to 2025's budget, not to Rachel Reeves' giant 2024 tax grab. To clarify all this, I'm going to re-link to the note from Ruth Gregory, our deputy chief UK economist in the podcast notes. But that's it for this week. We will be back next week with more for the world of macro and markets until then. Goodbye.