High government spending and the need for major economies — from the United States to Britain and France — to turn to bond markets to finance their spending have added to the list of concerns for some policymakers and investors.
The year started with a sell-off in global government bond markets, with Britain in particular left reeling.
France’s inability to implement austerity measures due to political instability has also affected its position in the financial markets. And rising U.S. Treasury yields are raising some doubts among investors that the new U.S. administration will rein in the high budget deficit.
Not surprisingly, talk of a bond refund is on the rise.
But who exactly are conservatives?
Coined in the 1980s, the term refers to debt investors who seek to impose fiscal discipline on governments they perceive as wasteful by raising borrowing costs.
This can also apply to monetary policy. If investors feel that central banks and governments are failing to prevent inflation, they may demand more compensation for lending.
Higher government borrowing costs spill over into higher lending rates for consumers and companies, putting economic and financial stability at risk if they get out of control.
Where did they go and back?
Bond markets were positioned in the 1990s as U.S. President Bill Clinton’s administration prioritized balancing the budget after initial spending concerns caused a jump in Treasury yields.
In subsequent decades, central bank bond purchases in the United States and elsewhere played a powerful role in reducing government borrowing costs, particularly after the global financial crisis of 2007–2008.
But rising inflation since 2021 and rising government spending, exacerbated by the pandemic and a spike in energy prices following Russia’s aggression in Ukraine, mean bond investors are now carrying more of the burden, along with central banks pulling back from bond purchases.
What else has changed?
Today, the focus is on the rise in government bond issuance, while there was inflation in the 1980s, says economist Ed Yarden, who coined the term at the time.
Although inflation is sticky, it has fallen in major economies and debt is piling up.
The US budget deficit has reached $1.833 trillion for fiscal year 2024, or 6.4% of economic output, the highest outside of the COVID-19 pandemic. Britain’s public debt has reached 100% of economic output for the first time in recent history. Germany is the only G7 economy with a debt ratio below 100%.
Where have these vigilantes been operating lately?
The biggest example is England. Borrowing costs rose one percentage point in a week in 2022 as bond investors feared plans to cut taxes and raise debt at a time when national finances were already under pressure. This forced a policy reversal and the resignation of then Prime Minister Liz Truss.
Long-term UK government bond yields hit new multi-decade highs on Monday as global debt concerns remained in focus.
Last year, the premium bond investors demanded to lend to France over safer German debt briefly hit its highest level since 2012 as political turmoil stalled efforts to cut the budget deficit.
Emerging markets are also under pressure. Brazil’s borrowing costs rose in December, hitting a new record high against the real dollar, as markets tested government spending plans and a widening budget deficit.
So are they really that powerful?
History bears this out, and Yardeni believes their strength stems from the rise in outstanding debt in recent years.
US Treasuries have grown to $28 trillion from $20 trillion before the pandemic and less than $5 trillion before the 2007-2008 global financial crisis.
However, bondholders do not have the influence in Britain that they have elsewhere. The US deficit has not fallen despite concerns, and French politicians have torpedoed the austerity budget, even as the prime minister warned it could lead to a fiscal “storm”.
Still, analysts say the more than a percentage point rise in U.S. Treasury yields since late September partly reflects bond investors expressing concern over the incoming Trump administration’s spending plans.
But the prospect of interest rates staying higher amid a strong economy also boosts returns.
—Dhara Ranasinghe, Reuters