Start discussing the bond market at a dinner party and most people's eyes will glaze over. Even the name has a clear meaning. «James Bond» was «the simplest, most boring, most straightforward name I could find,» Ian Fleming once said of his protagonist.
But the bond market deserves attention. Britain is on track to borrow a record £206 billion from private investors this year as Rishi Sunak embarks on a pre-election debt binge.
Meanwhile, the Bank of England is no longer buying bonds as it did in pandemic time. In fact, it sells them out.
This means Sunak is increasingly relying on financial markets to buy gold bonds (as British government bonds are called) or the kindness of strangers, as former Bank governor Mark Carney famously did.
This opens up the prospect of a new era of so-called bond vigilantes, those who enforce strict financial discipline on the governments to which they lend money.
The stakes are raised only because this is an election year, when both the government and the opposition will be tempted to make promises of lavish spending in an attempt to win votes.
Vivek Paul, chief investment strategist at BlackRock in the UK, warned this week that more promises mean «the greater the likelihood of the return of bond vigilantes.»
Their power should not be underestimated. Bill Clinton was forced to focus on reducing the US deficit after what became known as the «Great Bond Massacre» in 1994. More recently, bond vigilantes were blamed for raising borrowing costs in Italy, Greece and Spain during the decade-long eurozone debt crisis. back.
As Bill Clinton adviser James Carville once put it: “I used to think that if there was a reincarnation, I would want to come back as President or Pope. Now I'd like to get back into the bond market. You can intimidate everyone.”
Who are these new bond kings that can be so intimidating? One of the important City characters is Ed Balls' younger brother, Andrew, who is the lead bond trader at Pimco.
He joined the bond investment giant in 2006. Six years later, his firm was selling securities at high prices. the time when his elder brother was shadow chancellor. Andrew Balls took his share of a £57 million bonus in 2012 and bought himself a £6.5 million house in London's Maida Vale. Since then, his profile has only grown. «He's very big,» says one banker.
Still, he is not seen as a bond king capable of confounding policymakers, as billionaire Pimco co-founder Bill Gross once was. It is not suggested that Balls is seeking to position himself as a vigilante.
Other City executives point to senior bond traders at Artemis, Jupiter and M&G as possible vigilantes. But none of them seem to be able to strike fear into the markets.
For example, Harry Richards, manager of the Jupiter fund, is cautiously positive on securities, saying now is a good time to buy the market. He suspects the economy will slow sharply, ultimately pushing borrowing costs lower rather than higher.
Some wonder whether the era of the dominant «bond king» may be coming to an end. Gross, who defined the type and once memorably said that securities «rest on a bed of nitroglycerin,» retired from active money management in 2019.
Today's bond investors are much calmer, says Trevor Greetham, portfolio strategist manager. at Royal London Asset Management.
“In the mini-budget, everyone was screaming at the top of their lungs, but there was no obvious vigilante. Gold investors are typically life funds and pension funds. Institutional investors don't tend to jump up and down.”
Former pensions secretary Steve Webb, now with pensions consultancy LCP, says: “The two main buyers of securities were pension schemes and the Bank of England. . Both are now turning to sellers.
“It will be the major change in stock market dynamics, not the judgment of superstar fund managers.”
Pension funds have been increasing bond holdings over the past 20 years after how regulators pushed them into seemingly safe investments.
But pension funds and the Bank of England's quantitative easing (QE) bond-buying program have created an «artificial bubble» in government bonds over the past decade, says Dutch private bank Van Lanschot Kempen.
The bubble is now bursting.
The bubble is now bursting.
The bubble is now bursting.
The bubble is now bursting.
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Banks have so far taken advantage of the opportunity, while individual savers have also rushed to take advantage of the high interest rates offered last year.
James Lynch, investment manager at Aegon, says returns above 5% were enough to attract private investors to the market last year.
“The problem with securities now is that if the market is right, and the Bank of England is cutting interest rates this year, government bond yields should also fall,” he says.
“But does this mean that retail investors are less likely to step in and buy government bonds if they offer lower returns?” ? It will be an interesting dynamic — who will buy it instead?
The only saving grace is that the UK is not alone in facing these problems. Bond investors will be less likely to punish countries for profligate borrowing if everyone is doing it.
Robert Tipp, head of global fixed income at PGIM, says governments across the rich world have accumulated debt that would have been considered staggering a few decades ago. As long as the UK doesn't stand out too much, international investors won't view its debt as overly risky compared to other governments.
«Everyone's debt is now 100% of GDP,» he says. . “Most developed countries, such as the US, UK and France, are getting away with it by not being able to return to the lower debt-to-GDP ratios they had on average 20-40 years ago.”
It's not a free lunch: interest rates on government bonds are gradually rising, he warns.
Vigilantes may come to the rescue if inflation is not defeated and the Bank of England is forced to maintain higher rates for longer.
If the government insisting on large borrowings — especially if there are hasty campaign promises made during the election — could make investors nervous.
Once a sale starts, it's hard to stop. Traders don't want to own securities in a falling market.
Bond market veteran James Athey says, «There's a collective psychology to it.»
“It's hard to argue with the fact that we've seen a lot of vigilance, but if there's one mature market we're in, it's probably the UK — which is what happened in the Liz Truss era. If you define a vigilante as the bond market disciplining the government, then that's exactly what has happened.»
This is one reason the Chancellor has been so keen to emphasize his cautious approach to public finances.
It's still working. The Debt Management Authority has had no trouble raising money this year, with its latest bond sale, which raised more than £10 billion, being heavily oversubscribed. Investors have offered to buy three times more debt than was available.
However, markets will be watching for any drop in coverage ratios to much lower levels as demand levels are known.
The election campaign may also heighten tensions, Athey says: “If you had some tax-weak language, especially from the Labor Party, because they are so clearly expected to win, at a time when the [gold bond] delivery schedule is tight, it could combine create vulnerability.”
The bond market may seem boring at first glance, but hidden dangers lurk below.
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