The Global Bond Vigilantes are Finally Back!
The Global Bond Vigilantes are Finally Back!
UK’s new mini-budget and the market concerns over 45 billion of unfunded tax cuts fiscal measures caused a circular loop even though 1.3% of gdp and largely leaked before-hand.
Why?: We are in a new market regime the Global Bond Vigilantes are Back, combined with poor liquidity, Basically additional stimulus = More inflation = Additional rate hikes from Bank of England and Higher debt servicing costs.
The key in the short-term for the UK will be (1) Any climb-down if at all, on spending including tax cuts including the higher end, (2) More transparency on how to fund the package more details on November 23rd, and (3) Any possible intra-meeting rate hike and pressure from ratings agencies as we witnessed from S&P last week.
Regime change:
· This is not a UK-only phenomenon. Globally debt has increased by $110 trillion since 2009, no major countries are spared. Many European governments are understandably having to cushion the blow of natural gas prices this winter. Global government bonds are down 3.2% during September the largest one month drop in recent history and 18% for 2022. Together with the deterioration in the government finances, UK and global asset prices are likely to remain volatile, especially given the UK’s reliance on foreign investment to fund the current account deficit of 5.5%. Europe’s current account deficit has also turned negative due to the energy crisis. Germany has its first negative trade surplus since 1991. As a result of the war and the expensive energy imports put pressure on the Euro and yields as well.
· The global stock bond correlation has turned negative to positive this year , ie, lower bond prices and lower equities and vice versa. This is why both bonds and equities are down. Treasuries and sovereign debt aren’t a hedge like in 2008. This is a monumental shift and not what investors are used to over the last twenty years of falling inflation, low interest rates and rising financial assets. However, last week highlighted how global bond market is much more sensitive to levels of debt and debt sustainability.
· In short, the “global bond vigilantes” who have been in hibernation since the early 1990s are finally back. This means any excess leverage in the system, such as LDI, which never would have modeled this level of inflation or upward move in rates may cause shorter-term volatility. Ironically, consumer and corporate balance sheets are overall healthier a huge proportion of debt sits with governments due to the pandemic. However, highly leveraged corporates, governments, and consumers are at risk. Be on the guard of hidden leverage events in coming months given the unprecedented speed of rate hikes and the absolute move in yields in percent terms.