Bonds back in the driver’s seat: Inflation woes mean ultra-easy monetary policy won’t happen again anytime soon, says HAMISH MCRAE
It’s bizarre. First, we had the story that there was a black hole in the country’s finances, and things were so dire that they had to cut back on winter fuel surcharges to try to fill the hole.
Then Rachel Reeves told the party conference that everything would get better and that good times were ahead.
And now the Office for Budget Responsibility is apparently going to give her room to borrow more by adjusting the budget rules, as Patrick Tooher explains today.
First, we had the story that there was a black hole in the country’s finances. Then Rachel Reeves told the party conference that everything would get better
This is not related. Changing budget rules do not change the size of the national debt.
It just means we don’t have to worry about it as much. This doesn’t fool the markets. They are now asking us to borrow more than the US, despite America having both a larger deficit and a larger debt-to-GDP ratio.
At the beginning of this year, the yield on 10-year government bonds was 3.5 percent, while the 10-year US government bond yield was 3.9 percent. Now we’re up to 4 percent, but they’re down 3.8 percent.
Perhaps lenders can be persuaded to fund real public investment, but not if they are vanity projects that cannot be delivered, such as New Labour’s latest great idea, HS2.
There is a broader point here. The public finances of most developed countries are in shambles. Our national debt just passed 100 percent of GDP.
But of the G7, only Germany, and depending on how you do the sums, Canada, are better placed than us.
It may sound great to be able to borrow more, and while short-term rates continue to fall, I think yields on government bonds, government bonds and so on will remain reasonable. But history – and common sense – tell us that this relative peace will not last.
The big threat is that inflation will stop falling and start rising again. As and when that happens, the driving force behind current market confidence (perhaps overconfidence), the prospect of increasingly cheaper money, will fade.
Faced with higher inflation, central banks would have to start raising rates again, and if that happens, bond markets would demand higher rates to finance all that government debt.
They can cut rough. James Carville, Bill Clinton’s political strategist – best known for his statement ‘It’s the economy, stupid’ – also paid tribute to the power of the bond markets. “I always thought,” he said, “that if there was reincarnation, I wanted to come back as president or pope. But now I would like to come back as the bond market. You can intimidate anyone.”
Carville’s comment was made in 1994. When the central banks were throwing money around, that was wrong. The combination of low inflation, near-zero interest rates and a policy of quantitative easing meant that markets had lost their power.
But the catastrophe of double-digit inflation, the fear it caused central banks and the resulting social and economic damage, mean that ultra-loose monetary policy will not be seen again for some time to come.
So the bond markets are back in the driver’s seat, as they showed when Liz Truss refused to be intimidated by them. The damage they caused to the gold market brought down her government.
This government is terrified that this will happen to them, judging by that rather silly talk about not cutting winter fuel payments, leading to a run on the markets.
It’s impossible to see the details or the timing. I don’t think a strike by bond buyers is imminent here, in the US or anywhere else.
Governments around the world will introduce regulations and incentives to convince people to buy their debt. They will try to keep maintenance costs low. And they’ll allow a little more inflation to lower its real value, hoping the rest of us don’t notice.
The nature of markets, however, is that while things typically take longer to happen than anyone expects, when they do happen, they move faster and more viciously than anyone could have imagined.
Moral: Don’t invest in long-term bonds and if you can get a decent fixed rate on your mortgage, it might not be a bad idea to do so.
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