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¶ Unhappy Bonds and UK Crisis
Stock markets are so hot right now. People keep telling me with a straight face that the biggest risk in stocks today is that we're not taking enough risk. in stocks. Let's see how that one ages, shall we? Anyway, meanwhile, bonds not happy. Like they're really not happy. Bond prices are down, which means borrowing costs are cranking higher all over the world. Meanwhile, the UK has done what it does best and manufactured a political crisis out of thin air. So UK government bonds or GILT.
Or really feeling the heat? Today on the show What's Bothering Bonds, why do normies care and how can the UK avoid making a bad situation worse? This is on Hedged, the Markets and Finance podcast from the Financial Times and Pushkin. I'm Katie Martin, a markets column in the dungeon at FT Towers in London, which is inexplicably freezing cold. I'm joined, as usual, by the big man in New York City, Mr Rob Armstrong. Rob, uh do you have your special Yeah. Good.
This is what it's come to.
I'm joined right here in the London studio by our newbie on the Unhedged newsletter, Darren McFadden. You've been at the F T for like a month? You came from from from the Bank of England, you came from a proper job. H uh how are you how are you liking our funny ways? Is it a very different place to be?
I mean it's basically anarchic. I think my my imagination of how a newsroom functioned would have been an editor stood atop a command structure asking for this by five o'clock, this for tomorrow, and instead it all just comes together with everyone just doing their work.
This is what I I tell this to every time someone joins the F T. They say, you know, what do I need to know? And I tell them There are no rules and no one is in charge. And they think I'm joking. And then they work here for a couple of months and they come back and they're like, Oh, you weren't kidding.
Yeah. Yeah. Yeah. Let's just hope the editor doesn't hear this. Yeah.
Good heavens, yeah.
It's quite a grand building, the Bank of England, isn't it? It's like part of old London. It's one of the bits of old London that didn't get bombed back in the day. It must have been kind of quite a special place to work.
Yeah, weirdly, I mean, from the outside it looks like a beautiful building, but there are all sorts of downsides to working in a, you know, hundred year old building now that Uh the single glazed windows, it's very drafty, you have to walk ten minutes to get to any meeting room. Yeah. So it is a relief to work in a more modern office building.
We're dead glam here.
¶ UK's Fiscal Pickle and Gilts
So look, we're the F T, we're a London institution. So let's start with the UK. The UK has got itself into a bit of a pickle here, right? Like so The UK government bonds market, which everyone calls the Gilts market over here, like we borrow a lot relative to the size of our economy. But um we're like really tiny in the global scheme of things. We're much smaller than treasuries and so that does mean that we sometimes
muck it up and um and guilts get really volatile. In a nutshell, Dara, what is going on at the moment?
Well to start with, yeah, like you said, Katie, the the size of the UK guilt market is a lot smaller than the Treasury market. So there's a lot more of a risk that uh investors in guilt would lose interest in being invested in guilt. At the moment, the UK is in this very tricky situation of being at the center of both global dynamics that are pushing up yields internationally. and a sort of political crisis taking place in the UK now, which is adding to the yield on the longer dated guilts.
Can I provide some context here as as the Crass American? I am looking at a screen here that has all the European bond yields on them, the ten year bond yield. And nobody is close to the United Kingdom at five point oh one percent as of this morning. Italy three point seven eight. Italy Nah all respect to Italy, but fiscal responsibility is not their national motto. And uh what w I I I just don't understand why the United Kingdom is so out of whack with the rest of the continent.
Rob that we're not we're not in the eurozone, you know.
I said the continent. And I I think the islands that make up the United Kingdom as part of the European continent. The same way Long Island is part of the North American continent.
The same way Canada is part of the US.
The geography podcast.
Maps on the radio. So look part of it is we're not in the same currency. Like, you know, Italy uses the euro, Greece uses the euro, France uses the euro, Germany yada yada. We use sterling, so it's like it's not quite comparing apples with apples. And we don't have the same central bank, so we don't have the same base rate between the two. So like European benchmark interest rates are like two percent. Like yeah. And you know, w we're we're uh what are we at, Dara?
We are at four point two five.
Der Derek actually set that interest rate before he quit that uh job to join us here at the Unedged.
Thankfully I never had to work on monetary policy.
It's too hard. It's too hard. So look we're we're we're at different we're at completely different starting points, but nonetheless Cannot sugarcoat it. UK borrowing costs are higher. We've got more of an inflation problem than a lot of other developed market economies. We've got this piddly little bond market that's just not on the same scale as as certainly as the US.
And also if you're in Europe, if you're in the Eurozone, then you enjoy like the the a sort of safety net from a like an alphabet soup of rescue programmes that are out there at the European Central Bank that it can kick in. for pretty much whatever reason it wants, pretty much what you know, whenever it wants. If if one national bond market goes haywire in Europe, they can just hose that down.
So there's a safety and numbers thing there, basically. Maybe that's a bit of a simple...
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Mm. The European central bank is willing to kind of step in in the event that the spreads between all of the European bonds start diverging too much. That's that's critical to maintaining a single currency area. We have a central bank that is uh willing to backstop the market when there's a sort of systemic risk to financial stability, as happened in September twenty twenty two.
But that was to do with the business models and the balance sheets of particular sectors in the economy, like pension funds and insurance companies.
Have we hired someone who knows what he's talking about, Katie?
I know I
I thought we had a rule about this.
I'd say one other thing to bring into this, or a couple of other things. One is that the UK does have a very high level of debt as a percentage of GDP. And so yes, it's a piddly bond market, but it is large by European standards.
You're right. We we've got a lot of outstanding debt. And here's a little thing that uh the UK Chancellor Rachel Reeves is always pointing out, which is one pound in every ten pounds the public sector spends now goes on debt interest. Which is four times what we spend on nurses. Mhm. So like there's this idea, like politicians who are like, you know, on the outside of the tent pissing it.
are always like, Oh, we should ignore the bond market. The bond market is terrible. Why are we pandering to all these awful speculators? We should just do what we want and the bond market's gonna have to suck it up and it's like
No no, sure, that's fine. That's a political choice. But if you do that, you can't afford any nurses. But so you know, I I think there's this idea that the bond market is completely separate from from real life and from politics and that you can afford to like Just sort of do what you want.
The thing about the bond market, it's made of money. You know? This is this is a very important fact about it. And th that demands respect.
And also you should care what proportion of your debt is held by overseas investors. So the UK over the last couple of decades, or even less than that, over the last decade, it's seen a growing share of its public debt held by overseas investors.
These are people who have choices which public debt they want to invest in. And they don't need to stay invested in guilts. You know, if guilts don't provide a good return on investment and if they don't think that the government has a credible strategy for getting uh you know, keeping inflation close to target and getting fiscal expenses down, then they can shift into treasuries or bunds or, you know, some emerging market asset class.
I noticed the Australian tenure is also paying five percent. So you can flip over to Australia and get the same yield.
And also there's the currency thing, right? So if you think sterling's gonna weaken a lot, then why would you want to hold the bond? So th there's a lot going on here, but So there is a whole global situation which we'll come up come on to in a minute, but i in the meantime, so while we have got borrowing costs pulling higher across the whole of the world and the UK is quite sensitive to that anyway.
In the middle of all that, we've had some local elections in in in the UK that have been like a big punch in the nose for Prime Minister Keir Starmer. All of a sudden other people in and around the the Labour government
want to get in on the act, want to like, you know, oust him out of his job. It also looks like other parties that are much more to the right or to the left are kind of more credible uh they've got a more credible claim on on on government really in in the next uh general election.
So again, like just as Darrow was saying, if you give people a reason not to buy gilts, then maybe they just like won't buy gilts and there's an element of that that is making the situation for the UK market a a little bit worse.
Shall we go to the world now? Shall we broaden the lens to the world?
¶ Debating Bond Market Solutions
Just really quickly before we go to the world, so I wrote at the weekend about look Bond markets are important and bond markets are our friend and if politicians had any sense in the UK they would stop antagonising the bond markets and just accept some of the constraints and trade offs that we all live with.
I got feedback on that from people on the internet, some of it constructive, some of it not, but some of them were like genuine questions that I think are not stupid. One of them was, Well, why can't the Bank of England just buy all the bonds? Dara, why can't the Bank of England just buy all the bonds?
Well, the Bank of England has bought a lot of the bonds over the last eighteen years. Um it it is now selling a lot of them back into the market. That's part of the reason that the yield is is being pushed up. But one reason you don't want the central bank to be an outright holder of a large proportion of the of the public debt is that
Um that can contribute to inflation. You know, if you have the central bank monetizing the debt, then there's no constraint on the government's ability to issue uh or to make new spending commitments. So it is it is in principle it's a good idea to have a central bank with a a relatively smaller footprint in financial markets and allow the price discovery to take place in the market.
Yeah.'Cause if inflation gets out of hand, bonds really hate that.
I mean it's printing money. Issuing bonds and having the central bank buy them is printing money.
You're not wrong. And it's fine in a crisis, right? You know, to get you out of a hole. Everyone says, Oh, you know, we we hate printing money. Oh oh there's a massive recession, you say. Sure I'm gonna print that. Yeah. It's inflation. So that's that's why the Bank of England doesn't just buy it all. Another question that someone was asking me, and I can't tell whether they were being entirely serious serious, but ooh.
You know, to Rob's point, why doesn't the UK just issue all its debt in Euros if the yield is cheaper there?
Well, we've heard this recently. We there was a column in the F T actually from somebody suggesting this. Um but again it kinda comes down to the point about the um What view you want to take on the value of sterling and whether that's going to stay constant or depreciate. And so it would be a bit of a a punt uh for for the government to start doing.
And it makes local Oh I'm sorry, I keep interrupting even worse than usual. Go ahead, Katie, please.
And like i if if we Brits issued everything in Euros and then the value of the Euro went up a lot for whatever reason that we can't control
Then we
we're screwed and we're suddenly paying back debts that are much, much more expensive. So various countries in Central and Eastern Europe Poland and Hungary They had lots of like back in the day they had loads of debts like mortgages that were in Swiss francs. Anyway, Swiss franc blasted higher, a lot of people got absolutely annihilated. So if you're not issuing in your own currency, you're introducing risks that kind of don't have to be
This is what happened during the Asian financial crisis where you had all of these countries in Southeast Asia who had issued debt in US dollars. And then when the money flowed out, they didn't have the dollars to make those interest payments.
Yeah, yeah. So bad things can happen. The third sensible question that people have been asking me about why the UK market is in such a hole is
¶ Universal Bond Yield Pressures
Look, if bond investors like it so much if governments are boring and sensible, then why is the US government bond market not bleeding out at the moment? Rob, I will throw that to you.
I think it's because of the size, liquidity, and structure of the market rather than the quality of the asset. So it's a universally accepted, highly liquid, large, easy to access market in a currency that everybody understands and wants. So in global bond markets it pays to be the biggest and the US is the biggest.
Yeah. The US has this exorbitant privilege of being the world's dominant reserve currency, dominant reserve asset. It can get away with stuff basically that no one else can. So if the Brits try and be all American, then we get absolutely flayed for it. as we were saying right at the top, like the the real problem with what's going on with Gilts at the moment is that everything is is is really under the kosh. So even Japanese thirty year bond yields are getting close to four percent.
Cảm ơn các bạn đã theo dõi.
just earlier this week had to issue was it ten year debt rob or thirty year debt?
Thirty years.
Over a five percent.
For the first time in decades it's a five percent yielding piece of paper from the United States government. This is a big moment.
Robert Armstrong, tell us why this is happening.
I think it's gl it's global to a certain degree. I think there are global concerns about inflation, and probably even more than that, there are global concerns about fiscal responsibility on the part of the You know, the developed world's government. Right. So we want more we want more yield because we want more inflation insurance. But more importantly than that, the developed world is more and more indebted.
So it's worse and worse the credit. And so you need a little bit more. You know what I mean?
So th things that bonds hate include inflation and they hate having loads and loads of bonds. You know, it's just a supply and demand thing, right? If you have loads of bonds flooding the market then the value of those things goes down. What we're looking at partly as a result of what's going on in Iran is
inflation and loads and loads of new bonds to help governments pay for defence and a green energy transition and all of that sort of stuff. So it's just a combination of stuff that that bond investors really hate. And like so just earlier this week there was some nasty inflation data out of the States, right, Rob, that you had PPI inflation, that's like wholesale inflation, sometimes called like factory gate inflation. Like
What producers are paying rather than what consumers are paying. It's like, you know, CPI for companies basically. And uh it was very high. All the inflation numbers are a bit weird now because the energy crisis uh makes everybody a little makes all the numbers a little jumpy for reasons and companies are changing prices quickly and so forth.
Uh I wouldn't say that either the recent CPI data or the recent PPI data radically changed the am picture of inflation in America. It was more like confirming. Yeah. Inflation is not dead. And it's everybody hopes the next report will be the one that shows we're going back to normal. Two percent is in sight. And each report comes out and it's just like we're in a three percent world people.
So US PPI inflation less uh that came out earlier this week was up six percent year on year.
And and uh there was some one timers in there. Whatever. Sure, sure, sure. The point is three percent world not getting better. Three percent and not improving. That's not it's not the nineteen seventies. It's not you know, nobody's paying for groceries with a wheelbarrow full of money, but we're not supposed to be at three, we're supposed to be at two. And that and over time the difference between three and two percent is is large, compounds into a big amount. So it's important.
¶ UK's Bond Market Outlook
So what do we think let's take it back to the UK. What do we think happens next? Do you like Dara, what are your spidey senses? Do you think this is all gonna get a lot worse before it gets better, or do you think this is a bit of flim flam button?
I think it could get worse before it gets better. I think one of the risks here is that there could be a challenge to Sir Keir Starmer, the Prime Minister. And depending on who comes out tops in that contest for the leadership of the Labour Party. There could be a swing or a lurch to the left. Uh that means slightly more uh spending, more social commitments.
And um it's just not clear that the bond market really wants to absorb all that additional borrowing. So there's a real question there around whether the bond market is going to kind of reimpose discipline on whoever comes into power if Keir Starmer leaves.
And um in fact there was a column in the FT yesterday arguing that you could actually be long on on on guilt because the bond market generally uh has a way of imposing discipline and constraints on uh on governments that Um get a bit too out of hand.
I think like a lot of sort of, you know, Brit investors who I speak to are like, Yeah, you know, this is a pretty bad situation. People outside the UK are like, Oh god, you Brits will figure it out. You always figure it out.
Like, I don't know I don't know how you're gonna make this work, but you're gonna make it work. You're not gonna do another like Liz Truss thing end of twenty twenty two. You're not gonna like throw a grenade at your national bond market because you saw that ended quite badly last time, so let's not do that again. But, um...
Basically my view. I think we're just adjusting to a new world of permanently higher debt levels and aging demographics and We will find some way to accommodate this additional supply, whether that's central banks buying it or uh cutting social spending. Yeah. Something else.
Deciding you're okay with the three percent world or whatever the number.
Yeah.
That's the way you make debts lighter.
Yeah, very few advanced economies have gotten back to their two percent inflation targets since the energy spike in twenty twenty two. And so the uh The question is whether they even have two percent inflation targets anymore. Are are they able to meet them over the medium term or not?
They're less of a target and more of a flaw now. I think we can all agree. We should have all taken advantage of zero interest rates and borrowed like mad. Piled into green energy, maybe we wouldn't be in the situation.
Somebody on this podcast has a two and three quarters mortgage for thirty years. I'm not saying who it is, but he's feeling
That's too.
I'm so good about it.
You and your 30-year mortgage. So look the moral of the story is, yes, we have a problem here, but everyone just calm the heck down about the UK. Otherwise I'll get very grumpy about it. Okay, we're gonna be back in just one second with long short.
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¶ Macarons, Shampoo, E-Bikes
Alrighty, it is time for Long Short, that part of the show where we go long a thing we love or short a thing we hate. I will go first. I had a a a tough assignment this week. I went to an event in Paris
I just wanna go along. There's a little shop in the Gare du Nord when you're about to get the train back to London that sells delicious little macarons and they are very, very good. It's about like thirty five euros for a box of these things to take home, but they They are fine and they uh they always make up for for me being away for a few days. Guys, what do you got? Rob what you saying?
I am short shampoo, which is, as every bald person knows, a frivolous product that the world does not need.
Rob, you should be going long shampoo because of all of the hair treatments that are coming in these days.
Uh good point. That's a good point, Dara. Thinking like a trader. I like that. I like that.
Dara, what are you saying? What's your inaugural long shot?
Short It was reported this week that LimeBike is going to IPO at some point soon. And they're a blight on the streets of London, I would say, because they encourage a lot of people who are not regular cyclists to get on bicycles with an electric power assist and uh zigzag in all sorts of directions.
I don't understand why there haven't been more accidents.
Well there has there have been. Yeah, yeah. In in emergency rooms here, the doctors have have taken to calling a new kind of injury line bike leg, which is when your your leg is broken from one of the bikes falling on your leg.
Before the lime PRs get onto us, I'm sure some people have a very nice time on line bikes. I'm just saying I find them annoying.
Right. And the reason I'm short line bikes is that I don't believe they last very long. I don't know what the shelf life of a line bike is because at least around East London where I live it's not uncommon to see them at the bottom of the canal.
Ah so there's an IPO to watch those annoying little green bites. Chaps, we're going to have to wrap up. Listeners, that's it for today. We are going to be back in your ears on Tuesday, so listen up then. Unhedged is produced by Jake. And edited by Brian Erstat. Our executive producer is Jacob Goldstein.
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Special thanks to Laura Clark, Greta Cohn, and Natalie Sadler. FT Premium subscribers can get the Unhedged newsletter for free and a 30-day free trial is available to everyone else. Just go to ft.com/slash unhedged offer. I'm Katie Martin. Thanks for listening.
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