The Great Bond Car Wreck — in Slow Motion

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1:47Stephanie Flanders:I'm Stephanie Flanders, Head of Government and Economics at Bloomberg, and this is Trumponomics, the podcast that looks at the economic world of Donald Trump, how he's shaking the global economy, and what on earth is going to happen next. Well, this week, I'm sorry, but we need to talk about bonds, government bonds, because investors have turned against them in a big way in the major developed economies in the past week, in what's been called a slow-motion car wreck that could affect us all, especially anyone looking to take a loan out or refinance their house. Now, remember that a sovereign bond is an IOU that a government sells to investors when it hasn't raised enough money in taxes to pay for all their spending, which these days is all the time.

2:25Stephanie Flanders:There's a lot that affects the price of that debt, but broadly, when investors are keen, the value of the IOU goes up and the yield, the interest rate the government has to pay, goes down. That happened for many years after the global financial crisis. Governments found borrowing cheaper and cheaper, but yields have been rising off and on since Covid, and last week, yields went up everywhere all at once in a way that made even the more grey-haired Bloomberg types pay attention. We're recording this on Tuesday morning, US time, and the yield, the interest rate, on the very long-term 30-year US Treasury has just risen to its highest level since the eve of the global financial crisis in 2007.

3:06Stephanie Flanders:And it's not just the US. In Japan and the UK, for example, the 30-year yield is the highest it's been this century. Now, this matters, obviously, for government's funding costs. taken together the past week could mean tens of billions in interest payments by governments that could otherwise have been spent on other things. But it also matters for markets as a whole, because of what it might tell us about the impact of the war in Iran on the global economy, the future rate of inflation, and also what it might tell us about the basic standing of the so-called advanced economies. Because you can't help noticing many emerging market governments have not seen investors running for the hills in the past week.

3:46Stephanie Flanders:In fact, many of their currencies have been going up. Well, there's so much to discuss, and my two guests have already written some excellent commentary on it that I thought was worth sharing on the show. Robin Brooks, a senior fellow now at the Brookings Institution, was formerly chief economist at the Institute for International Finance and chief FX strategist at Goldman Sachs. He writes a lot of good stuff on his sub-stack, But one piece this week entitled Liz Trust Bond Market Blowups particularly caught my eye. Robin, thanks very much. Waking up early on the West Coast for us. Thanks for having me on.

4:22Stephanie Flanders:And John Authors, senior editor for Markets and Bloomberg Opinion columnist, longtime Financial Times journalist. Welcome back to the show, John. Thanks for having me. I did steal in my quote earlier, I stole the title of your column today, the great bond car wreck in slow motion. Without going into everything all at once, briefly, are we right to be taking the last week pretty seriously? What's going on in bond markets? Yes, you should always take what's going on in the Treasury market very seriously indeed, because it ultimately is the closest approach we have to a risk-free rate. Yes, there's no such thing as a risk-free rate, but for any number of different financial calculations, the closest approach to it, the one that is assumed to be the risk-free rate is the 10-year treasury yields.

5:11Stephanie Flanders:So it's a base for everything else. It's a base that finds its way into an awful lot of financial calculations that you would not connect in any way intuitively to the treasury market. So it's a very big deal, obviously, primarily for US mortgages, for the US companies trying to raise finance, for Uncle Sam trying to finance itself. I think the other point to make is that there is perhaps a greater, more important meaning when global bond markets move together. So there are very specific local factors in Japan with Sanai Takeichi, with France, with the great difficulties there that Macron is having with the legislature there, with the UK and all the ructions at the top of the Labour Party.

5:59There There are certainly clear different idiosyncratic things going on in all of those countries, but it still has to be pointed out that it's difficult, if you look at a chart, to tell the difference between their bond markets. They have all started surging. Bond yields have started surging upwards at the same time, and that is ultimately because of uniform concerns about fiscal space and about inflation.

6:24Stephanie Flanders:Robin, I did see a nice kind of quote in one of the many Bloomberg pieces about this, was that the developed world has too much debt, too little fiscal discipline, and no political appetite for fixing either. Do you think that's been driving the last week? And why has it happened so quickly in such a short time? Well, I think that's the key question, Stephanie. And let me just add to what John said, three points. The first is that COVID saw fiscal stimulus globally of a magnitude and a global coordination that we've never really seen before. I remember talking to a policymaker at the time, and they said, you know, we don't know what the long-term consequences of this are going to be.

7:09So many countries issuing so much debt simultaneously. And I think part of what we're seeing in recent months, including this week, is the bill is coming due for that. The second thing is that the decade before COVID, we were all convinced that inflation would be low forever, that interest rates would be low forever. We were all telling ourselves that we were in a new paradigm and output gaps were big. And so that meant you could issue lots of debt without interest rates going up very much. And that caused governments to run deficits that, even after COVID, even with COVID long gone, are way wider than they were before.

7:56So if you look at the U.S. government, the deficit's running around 6 % of GDP. Other governments are running deficits that are way wider before COVID. So not only did we do a huge debt issuance binge during COVID, but we continue to run really loose fiscal policy. And then the third thing is that inflation, which we thought was always going to be low, has turned out to not always be low. We had the post-COVID inflation surge, and now we have Iran and oil prices and what that means for inflation. So I think, Stephanie, to come back to your question, all of what's going on in debt markets has been brewing for many years.

8:37long-term interest rates, which in particular capture risk premia and expectations among investors for what governments might do. And of course, the big bugbear is that governments will be tempted to inflate away debt, right? To print money, to lean on central banks, to make debt go away. I think all of these fears have been coming to a head over the past year. And it's not a surprised that in connection with that, we've seen the debasement trade. So, precious metals go through the roof. Okay, you've got to expect the debasement trade for those who might get

9:15Stephanie Flanders:panicked even more by hearing that. People buying any kind of safe haven asset that will protect them from governments inflating away debt. So, that is gold, silver, platinum, palladium, you name it, but it's also currencies and debt of countries with very low debt levels. So, for example, Switzerland is kind of the sine qua non, but Sweden, all the Scandys are part of that too. You make the point, John, I was struggling with last week, actually, because in the UK, obviously, there was a lot of noise coming out of Westminster. And in Britain, we like nothing better than to say that we're in the worst possible state relative to nobody else.

9:56Stephanie Flanders:And And everyone wanted to look at the bonds and say, the reason why yields have gone up so much is because this government is terrible and this government is a mess. And I found myself in a rather difficult position saying, well, that is true, but actually there's a lot going on. And in fact, the biggest factor that's increased the cost of government was these other things going on. And as you say, you can't necessarily tell the difference between their political crisis and the things going on in the US. But we've just been talking about long-term things, structural things, affecting the way that investors would look at bond yields.

10:28Stephanie Flanders:So you still might say, OK, but why has it all happened in the last week? I mean, is it sort of people suddenly realising that the Strait of Hormuz is going to be shut for a long time? Because they can't be suddenly realising that governments don't want to cut borrowing. There is. Malcolm Gladwell got rich with this infuriating concept of the tipping point without ever explaining exactly when or why a tipping point will happen. There are such things as tipping points. Plainly this happens in markets when some kind of a weird psychological turn or some point in mass psychology is reached and things start to move very fast.

11:04it would be ridiculous to say this is all about the strait of hormuz however plainly that's the trigger at the moment if you want to talk in in the short term about why particularly this was a trigger my best guess is that there was some hope out of the out of beijing last week that there would be some pressure from china on iran to to reopen the strait and it didn't happen evidently and if you look at prices for brent prices for december they continue to reach a new high for the crisis we're now above 90 for brent at the end of the year that is followed by people in uh in bond markets they are being told by the oil market that yes this isn't a transitory thing this is going to last for a while and therefore the risks for creating an inflationary impulse have risen ultimately again it's it's an irritating gladwell it's happened to happen last week if you wanted a specific moment last week that helped things run maybe let's try to make ourselves feel important as brits maybe the guilt market helps but the main thing is oil if we're really expecting crude to be above 90 by the end of this year which we weren't even a few weeks ago, there does come a point where you just have to act on that.

12:32Stephanie Flanders:We tend to say as economists, well, if you have these long-term structural changes, and in fact, our economists, you think that there's a kind of long-term increase in interest rates in the sort of neutral real interest rate globally from lots of big tectonic forces. But you tend to say that's manageable if it happens over time, slowly. A big increase like we've seen in the last week, and certainly the big increase in borrowing costs we've had since the start of the Iran crisis, then you start to worry US treasuries are the kind of central common denominator for the whole global financial system.

13:04Stephanie Flanders:And there have been worries at various times in recent past about the short-term liquidity in those enormous markets that you would have thought would never happen. Are you nervous about unexploded sort of grenades that could go off just from this move having happened so fast yeah if you remember back to long-term capital management or particularly to 2007 2008 you always have to be concerned about that um i think there's robin's piece covered some of our own analytics at bloomberg that i mean japan and the uk you can see some signs of stress but still nothing like the you know very serious financial accident that happened with there's no really clear sign of uh of stressed trading here in uh particularly here in the us obviously if there was that would be a reason for very great concern this looks more even if we've reached some kind of a tipping point more like a healthy as far as it goes a healthy adjustment a healthy realisation, then the concern obviously has to come into other markets.

14:19Are they really going to deal with what the bond market is telling them, which so far they, in many cases, are not. The other thing is if you've lived through 2007, 2008, you can get into this thing of, well, it's not as bad as that, so it's fine.

14:35Stephanie Flanders:It's true. We have too many terrible things to compare it to, it's true. Yes, it's not in that territory at all. but it ought to be healthy. There is no clear sign of really dangerous instability or illiquidity to this stage. Well, John, you're not a central banker but I suspect in a few weeks' time, depending on what happens, we can come back to you with healthy the way people came back to Jay Powell with transitory. Robin, I quoted your substack about the Liz Truss bond market blow-ups and I think when people hear that phrase they will think, oh, he's talking about great drama and crazy politicians doing things.

15:12Stephanie Flanders:But actually, you made a specific point that actually relates to this healthiness thing, because what we might call in a developed economy a healthy adjustment in bond markets wouldn't usually come with a fall in the currency. So that was the thing that you'd highlighted, and I just wanted to dig into that a bit. In the G10, so in advanced economies, typically higher yields mean a stronger currency, right? It increases the yield that you get on holding that currency. So it is very unusual to see yield spike and the currency fall. That is kind of what happens in emerging markets. And it is a symptom usually of policy credibility being relatively low.

15:57So that when you have a shock, people aren't confident that the policy framework is stable. And so they are worried about central bank credibility being undermined, the central bank being pushed into printing money, and therefore a loss of value across the board. And so they bail on the country. They sell all assets. And so the currency falls in addition to government bond prices falling and yields going up. The biggest example of this that we've had in the G10, or I should say the most volatile and kind of the loudest, was the UK in the LDI blowup in 2022 in September and October. But the thing is, we're seeing more and more of these instances across the G10.

16:47And I think that's symptomatic of us converging in the G10 down to EM. And of course, that also means EM converging up to the G10. And another example of a similar blowup is the U.S. in April 2025 when Trump rolled out reciprocal tariffs and everyone was wondering what was going on. The dollar fell as yields spiked. That was a very scary episode. And as you know, the U.S. Treasury market has major vulnerabilities because of the basis trade and the swap spread trade. Those are high pockets of leverage which wobbled at the time. And then the thing that I highlight in my Substack piece is Japan. Japan is the mother of all of this, has been in a LizTrust-style sell-off for two years.

17:41It's crazy, and it doesn't really get the attention that it should, but yields, especially at the long end, have been rising continuously. in any G10 currency setting, you would think that that would boost the yen, but the yen has been falling. And it is really, really worrying. And it basically, to me, says, if I think about what should the yield for Japan be, then with gross debt of 240 % of GDP, basically markets are saying, well, I would like a yield that's much higher. I want to be compensated for all the risks that come with such a high debt level, what we're getting is a far lower yield.

18:24And so I'm going to sell the currency. And so all the shenanigans that Japan currently is trying, and I'm referring specifically to official FX intervention, you know, that stuff, it just doesn't work. It's basically just signaling a government in denial.

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22:05Stephanie Flanders:Robin, the way you sort of particularly crossed my radar when I was sort of first involved in this world was as Chief Economist at the Institute of International Finance. That's the institution that sort of has particularly gathers a lot of good information on what's going on with investment flows across the world. And I just wonder, as someone who sat for a long time looking at both emerging market economies and the big G10 economies. Are we getting to the point that, or at least the trends that you're talking about, does that mean that you're going to start not being able to tell the difference?

22:34Stephanie Flanders:You know, if you're not given the name of a country and you look at their bond market, their currency dynamics, that you're going to start not being able to tell the difference between them. Are we already at that point? We're already well on the way to that. If you think of Eastern European economies, some of which are now in the EU, you know, back in the 90s, they were considered emerging markets. I think they, on most metrics these days, surpass some of the older members of the EU in terms of their fundamentals and debt levels. But let me give you a concrete example of an emerging market that really stood out positively after COVID, G10 central banks were trapped in kind of this pre-pandemic think bubble, which was inflation will always be low.

23:21And so they dismissed the inflation surge that happened after COVID. And then you look at a central bank in Brazil, which basically said, yeah, no, we're going to hike. And they hiked early and much quicker than G10 central banks. So we are seeing a shift. Of course, it's been a long time coming, as you say, and I think emerging markets, if you look at their currencies against the dollar, one of the things that I've been highlighting is that emerging market currencies are on a big trend appreciation against the U.S. dollar. And that's really about convergence of EM, central bank, and other policymaking, decision making, and credibility to the G10.

24:06Stephanie Flanders:It does make me think, John, we tend to talk about the US having an exorbitant privilege because of the dollar status. And obviously, that's still the case in many ways. But in a way, these G10 economies have been trading on a kind of exorbitant privilege that somehow they felt they could get away with having these very high debt levels. And they could do everything that emerging market economies do. But somehow, because they were, you know, developed and advanced, and they'd been around for a long time, they could get away with it. And people would specifically point to Japan as the example of that.

24:35Stephanie Flanders:Well, they still don't have to pay very much to borrow despite having these extraordinarily high debt rates. I mean, is that just now very rapidly going into the past? Yes, it is. But there are still some very important market effects of that dawning realisation. The one way to measure this that I think is is fascinating is the carry trade, which for the uninitiated is a very popular way of playing the foreign exchange markets where you borrow from a currency that has a low rate, such as most obviously the yen, and park it in a currency where you can get much higher rates, such as at the moment the Mexican peso, and you pocket the difference between those two interest rates, known as the carry.

25:27And providing there isn't a sudden turn in the interest rate in the exchange rates against you, you make money. The Japanese yen, Mexican peso carry trade has made a higher total return in this decade than the S &P 500. All it is, is just leveraging the fact that Mexico knows it's got a problem with inflation and will hike rates as soon as it sees there's a risk of inflation rising because it's an emerging market that's been hit several times in living memory by terrible financial crises because of this. While Japan is a country where you need to be about 60 years old to remember there being any problem with inflation at all and behave differently.

26:09And you can simply make that kind of money. You can do better than buying the US stock market just by leveraging that difference. Now, that cannot go on much longer, it seems to me.

26:21Stephanie Flanders:So you've mentioned the equity market. And I did want to ask you, maybe this is sort of the last bit of our conversation. But anyone listening to this would think, wow, the world's quite a scary place. I mean, not only have we got the obvious Iran war, but actually the market's telling us that inflation is going to stay higher, that the government's credibility across the advanced economies, the economies that still play an enormous role in the global economy, their credibility is shot. They're not able to convince investors that they're really going to do the difficult things to reduce their deficits.

26:55Stephanie Flanders:And we know that the voters in those countries don't want to do anything, don't want to face up to that reality particularly. But despite all of those long-term fears that are supposedly represented, embodied in this big increase in the cost of borrowing for governments, equity markets don't seem to have really noticed or cared. How does that work? To be fair to equity markets, as many of my readers kindly point out, that I have a strong tendency to be incorrectly bearish about stock markets. So to be fair to stock markets, there is something genuinely exciting happening in the earnings that are being generated by companies building out the AI and the earnings that are being generated by semiconductors in particular recently have certainly been uh that that would always give you a reason in the impulse to buy stocks that's what you buy when you buy a stock that's the future uh cash flow from the from their future earnings um that's that said yeah i agree i i it's it seems to me they ought to care a bit more well i mean the classic alan greenspan rule of thumb was to compare the earnings yields, which is the inverse of the PE, your earnings per share as a proportion of the share price, with the 10-year treasury yield, with the general idea being that when you can get a better yield from bonds, where the only risk you're taking is that Uncle Sam doesn't repay you than on stocks, that probably means stocks are a bad deal.