What's Behind the Bond Market Rollercoaster

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1:59John, thank you for joining us. It's a pleasure to be here. If you were at a dinner party with people who did not know that much about bonds, and they asked you, why should we care about this right now? I'm hearing a lot about this. What would you say? Okay, first of all, you seem to have a remarkably good insight into my social life. I'm very, very impressed by it. Are people cornering you, asking you about the bond market? I would say it needs to matter because globally, no number matters more than the 10-year treasury yield. And it matters because it's not just about how much Uncle Sam has to pay to borrow, but it is treated across the world as the closest approach we have to a risk-free rate.

2:41The U.S. government is not going to default unless it renounces its ability to print new money. There's a risk of inflation. There's no risk of default. It is the safest loan you can make to anybody. You can put your money in U.S. bonds. You know you will get it back. Yes. And governments and investors all over the world count on it for that. Exactly. So this is as close to a risk-free rate as exists. And so it's written into spreadsheets across the planet as the risk-free rate onto which you then add more to take account of the extra risk that goes with lending to Britain or Germany, which is not very much, or to Zambia or Mozambique, which would be considerably more, and so on, or to companies.

3:27The higher it goes, the higher the tougher financial conditions get for everyone.

3:39This is The Big Take from Bloomberg News. I'm Stacey Vanek-Smith, in for David Gurra and Sarah Holder. Today on the show, Bloomberg columnist John Authors joins us to unpack a bond market roller coaster, a sell-off, the highest U.S. 30-year bond yield since the financial crisis, and a sudden intervention. Why is the U.S. government jumping in? And what does this mean for the global economy? We taped this on Wednesday morning at 10.30 a.m. Eastern.

4:11John, you wrote on Monday that we have seen the yield on the 30-year U.S. Treasury go over 5.3 percent. So that means basically the interest the U.S. is having to pay on these loans, as a very basic way of putting it, but still, that is the highest it's been since 2007, which was, of course, the eve of the global financial crisis. And in many ways, that spike up to 5.3%, I would argue, sparked the financial crisis. And on Wednesday morning, the U.S. Treasury announced it would increase buybacks of U.S. bonds to help stabilize the bond market. So is that why the U.S. government is jumping in here?

4:48Because we're sort of in financial crisis territory? Certainly not in 07 territory. But in terms of are the same ultimate dynamics happening that this could create issues, that this is something we don't want to keep happening because it could begin to create problems in the economy. Yes. One other issue that is particularly troubling at the moment, which is an extremely positive sign for the overall economy, but has its negative side effects, is all the investment in AI. So, there are all these massive new data centers being built, which some people living nearby dislike. They cost a lot of money.

5:34Generally speaking, even the very big companies with lots of cash on their balance sheet that are building them are borrowing to do so. This is a very safe investment. Right. To lend to Apple or Amazon or whoever to build an enormous computer center for which there is demand. is only very slightly more risky than lending to Uncle Sam. It's a very safe investment. There is a lot of borrowing going on, and it's an appealing investment. And the way that you counteract that, if you're the government who also needs to borrow, is you need to offer a higher yield, which means you have to put up... There is more competition, and that competition basically forces you to reduce your price, the price of the bond, which means in the upside down logic we all have to live within bond market that the yield has to go up.

6:35And so you're in a situation where the economy is strong and lots of people are borrowing. In this case, you have a very specific shock in the form of the CapEx required to build out AI data centers. CapEx is the money that you need. The big stuff, the one-off really big borrowing you need to do to build the factory, which you hope will pay for itself. And once you've built it, you don't need to build another one. But this is a period when lots of companies are doing very big one-off investments and borrowing to pay for them. Okay. And that creates a further pressure upward on the yields that the government has to pay.

7:20Okay. So one of the reasons that we're seeing the 30-year bond in this territory is because there's competition. What are some of the other things that are pushing up treasury yields, that are making it more expensive for the U.S. government to borrow money other than the competition? I think you have to look at the scale of the fiscal deficit. Again, to be clear, nobody thinks that the U.S. would actually default. Right. What could happen and what historically does happen when the government has borrowed too much is that most politically painless way, perhaps the most humanly painless way to deal with it is to inflate away.

8:05Right. To make the money worth less. It's like, why owe you a hundred dollars? But if I make that money worth less, then I don't have to. I mean, I can pay you a hundred dollars, but you can't buy as much with it. Which may well be a defensible least worst option, to be to be clear. I'm not saying I like inflation, but I am saying it's not a plainly bad thing if politicians resort to that. It's a bad thing if you're a bond investor, though, because that eats away at the value of your coupon. Your coupon has been fixed 10 years in advance. I will be getting$10 in 10 years' time. If there has been 10 % inflation a year between now and then, I'm being paid far less.

8:44And now my$10 can't even buy a coffee. Yes. So I'm going to try to sell my bonds now, which will cause more sellers than buyers. Price goes down. So inflation risk. Yes. So the risk of inflation, the risk of debasement is always part of the concern. The classic way to express your risk that governments are just going to let inflation take off is with the gold. Yeah, people would buy gold because they were like, well, even if the money loses its value, gold will stay half. So we had an all-time high for gold earlier this year, which has come back in, but it's still at historically very high levels.

9:28So there is definitely a concern about, let's call it debasement, or another word you could use for it is financial repression. Okay, so reason number one is there's a lot of competition for money. Yes. Reason number two is inflation. People are worried about inflation and the debt that the U.S. has. Are there other reasons or are those the big two? You could possibly subdivide inflation plus in other countries just the fiscal overhang and there does become somewhat more of a risk of default. What's fiscal overhang? Sorry, where countries just have too much debt. Where the debt becomes overwhelming.

10:12Yeah. If you look at Japan, I've run a few charts on this. What has happened to Japanese bond yields is quite extraordinary because we've had decades when Japan had literally no inflation at all. That is no longer something you can assume in Japan. and bond yields have surged upwards and that's a problem because the overall debt in Japan is something like twice GDP. It's far higher as a proportion of the government than any other developed country. Does that mean it's going to default? I doubt that very much. Does it mean that something dramatic is going to happen which you may not want to be owning Japanese bonds when it happens yes that's plainly a risk and uh that would explain why people are getting out of uh getting out of japanese bonds and causing the the yield to go up so that that that would be the other one is is is classic the the phrase i think we did a big take about this a year or so ago is the notion of bond vigilantes who simply don't believe that you are going to be able to pay your debt and so start putting pressure on you.

11:29So what does that mean for people listening? Like, how do we see it for the non-bond buyers of the world? What does this mean or what might this mean for us? First of all, most of us don't consciously buy bonds, but most of us do actually have quite a direct exposure to bonds. You're secretly buying bonds. Well, if you've got a 401k, there's some bonds in it. And if you've got a traditional pension, your income in retirement is going to be dictated by the bond market. And your mortgage rate, okay, it's fixed, but the rate you obtained it at was determined by the bond market. And if you're thinking of getting a new mortgage, you need to pay attention to the bond market.

12:12Business loan, if you're looking to expand your business, start a business? Ultimately, we'll be tied to, ultimately, we'll be related to this. Less the 10-year, more the shorter-term bonds. But ultimately, there are links throughout. Inherently, it's not a bad thing when an economy is doing well, which overall, we know there are equality issues, but overall, the US economy is doing well at the moment. Yes, yes, very much so. There's no question about that. Whether it's fairly distributed is another matter altogether. But in principle, when growth is strong, bond yields rise a bit to make sure people don't go overboard.

12:55That is actually a good thing in principle. It's one of the natural regulating mechanisms of capital markets. What would worry me most about this is that it could feed into greater issues with inequality. When yields go up, when credit is tightened off, broadly speaking, the people who are least creditworthy will feel the effects first. It gets more and more and more expensive for them to borrow money. Until they basically don't. All other things equal, higher yields on bonds mean that bonds become more attractive compared to stocks. They pay you a guaranteed yield. Stocks, you have to take a risk.

13:53They probably pay you better, but you're taking a risk. Right. Stocks, you make more money, but they're riskier. Bonds, you make less money, but they're safer. So all other things equal, this should be bad for the stock market, higher yields. Yeah. It isn't having that effect so far. At a certain point, higher yields can turn into people exiting the stock market. That has been another driver of inequality, and a lower stock market reduces inequality in a bad way by making the richer people poorer rather than making the poorer people richer.

14:34So that is where things stand at the moment. After the break, why the U.S. Treasury announced an increase in buybacks and how that could change the bond market math.

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17:24So, John, on Wednesday morning, the U.S. Treasury announced it would be buying back a bunch of bonds. What impact did that announcement have? The immediate effect as we're recording this is that they've managed to bring the yields down fairly sharply. How does that help? It's similar to when a company buys back its own stock. Okay. You put up the value of them because other people are... Is it like artificial competition a little bit or...? Yes. Sorry, I had a classical education. I was going to say it's like a deus ex machina. It's like this big god figure that gets wielded into a Greek tragedy.

18:03I like this. It just comes in and there is a new source of demand from somewhere. And it pushes the yields down. It costs the government money to do this, but if it calms everything down in the bond market in the medium term as when people were beginning to get nervous, it may make it cheaper the next time it wants to raise debt because the yields in the markets have come down. Also, again, we're not talking about a major disorderly crisis here. We're talking about bond yields getting a little too high for comfort and the government responding by prodding into the market, obtruding, using some of its taxpayers' money in the market to try to prod the market back in another direction.

18:58Okay. So if we're nearing the end of our dinner party and you keep referring back to these crises, which is, of course, quite scary. Yeah. But you've said several times, this is not that. We're not in crisis yet. Yeah. Why is this moment different than 2007? Okay. The main reasons this doesn't look like 2007 to me, the reasons I don't think this is that bad, subprime credit was enormous and was plainly overdone. Like lots of people - A lot of bad debts. Lots of people had received debt, had received loans who plainly shouldn't have received them in the first place. Okay. And that debt had then been repackaged and resold in such a way that people weren't sure who exactly held it anymore.

19:59And we eventually discovered that lots of banks in Europe had bought the debt. And so that became a crisis of Europe's sovereign debt. That crisis went on for years. And this moment? And at this moment, mortgage debt in this country, the problem is almost the other way around, that people can't get into the market, that house prices are such and the rates at which people borrowed are such, that the problem is almost the reverse, that it's too difficult to get into the market in the first place. That's a social problem, but there is no great risk that mortgages aren't going to pay off. Similarly, we can complain bitterly about how a group of companies are oligopolistic or monopolistic and are hoovering up all the money and are charging too much and making too much profit.

20:55All of those are valid criticisms and complaints. They're good for their debt. Right. They can pay their bills. Yes. If Amazon reneges on its debts, that is a very shocking thing. It's far less likely than the number of people who had borrowed mortgages, borrowed and bought houses with ninja loans. I don't know if people remember that, no income, no job. Oh, yes. There isn't a contemporary equivalent of that. If there are losses to be taken, broadly speaking, they will be taken by people who have the broad shoulders to take them, such as the very big companies that we're all complaining about.

21:41As said at the outset, the 10-year yield is the most important number in global finance. It has to be respected. you could argue that a raising yield heads off problems before they get too serious if people are listening to it. It's part of the balancing mechanism of capitalism. Like the canary in the coal mine for the economy. What we are seeing here is more of a frog being boiled slowly. That doesn't lead to a crisis. It does lead to the kinds of dynamics that we've been discussing. and if nobody pays attention and i guess scott bessant's showing that he's watching by intervening to try to get the yield down shows that people are paying attention if nobody pays attention there is the risk of something disorderly finally happening of the bond market just saying okay we're tipping we're getting out on mass and that can lead to something scary but it's almost the speed of the rise in the yields, the speed with which they lose confidence that would be the problem more than the rate itself.

22:49That is the alarm. And that is why Scott Besant is trying to calm that market, whether he is then able to deal with the longer term concern, which is convince everybody that the US has debt that it can finance without just allowing inflation to take off. That is a much deeper, longer term concern. Well, John, thank you so much for coming and talking bonds with us. Thank you. And don't ever go to a dinner party with me. This is The Big Take from Bloomberg News. I'm Stacey Vanek-Smith, in for Sarah Holder and David Gurra. To get more from The Big Take and unlimited access to all of Bloomberg.com, Subscribe today at Bloomberg.com slash podcast offer.

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