Breaking down the bond market

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0:42So how come loads of people don't even know the bond market exists? And how come the specialists can't figure out what it's up to? Today on the show, a full-on bonds fanboy will share his thoughts. This is Unhedged, the markets and finance podcast from the Financial Times. I'm Katie Martin, a markets columnist at the FT in London, where it's getting pretty chilly. Joining me by the magic of the internet all the way from the frozen north of Oslo is the most English-sounding Norwegian person you can imagine, my colleague, FT Alphaville editor and presenter of the Story of Money podcast, Robin Wigglesworth.

1:21Robin, how are you doing? I'm good. I'm quite cold, unfortunately, though. Winter has arrived here. when does it start snowing we've already had our first snow outrageously that did feel like a slap in the face i mean it was only sleet and it disappeared i was not ready for that that felt like a bit of a shock even for Norwegian okay you have been warned now uh Robin you're here to talk about bonds let's rip off the band-aid here you love your bonds so much that you just wrote a book about them which is available in all good bookstores and probably some bad bookstores now Wow. Why have you written a book about bonds?

1:59Why do you love them so much? I mean, they are what the cool people are interested in, in finance. It was the first stuff I covered as a journalist, actually. I covered Sukuk, Islamic bonds. They're kind of worth talking quack like conventional bonds, but they're structured in kind of finicky ways to get around the prohibition against usury. And I've just kind of realized that really, if you want to understand finance and the global economy, you have to understand bonds. How big is the US government bond market compared to the rest of the world? And is it still clinging on to that absolute centrality in the global market?

2:36Its importance is even greater than the relative size. It is the bedrock of the bedrock. It's kind of the molten core at the centre of our financial planet, essentially. US government bonds have this very special place in global finance. And one of the things that that means is that they boss around the rest of the market. So if you're like some tiny little island in the Atlantic, like the UK, then it doesn't matter how good your government is, how sensible its fiscal plans are, how much it wants to borrow or not. That's kind of on the margins. There's a good chunk of how much it costs the UK government to borrow that is determined by whatever it is they're up to over there in the States.

3:14And that's like, that seems like really outdated and weird to me, but you can't get away from it, can you? No, I think it's kind of baked in the cake at this stage. I mean, the bond market, the reason why it's so influential and so important is because it kind of represents the cost of money for everybody. So like if you have a mortgage in the UK, you are basically competing for money with the UK government. So the UK government kind of what it pays to borrow kind of decides what UKT have to pay for your mortgage as well. So when the UK bond market throws a wobbly, then suddenly you have to pay your mortgage costs more.

3:48but annoyingly the US is so big and it's so important and dollars are so important to the financial economy of the world even me in Norway when I borrow money from my bank I'm basically also competing not just against the Norwegian government which thankfully doesn't borrow that much but I'm also competing against the US government because my bank in Norway can always have a choice between lending me money for a house or a holiday or lending money to the US government Lo and behold, sometimes outrageously, it prefers to lend money to the US government. Don't they have any idea who you are? I know.

4:23Yeah, I've tried going into the bank and saying, don't you know who I am? Unsurprisingly, it did not work whatsoever. So Robin, because you and I are such exciting people, we think about bonds every day. But for a lot of people, they can be really hard to understand. Why do you think that is? Well, they are more complicated. They really are. There is more math involved. That's why we kind of always think of people in the stock market as the slack-jeweled yokels of the financial industry. If you'd like to complain about that, listeners, email Robin, not me. Yes. So my email is katie.martin at ft.com.

5:02But yeah, bonds are more complicated and they can move up and down for good and bad reasons. And then the yields, we talk about both the bond prices, but yields, they move in the opposite direction. and bonds can sell off for good and bad reasons. Let's say if we worry about the United States going bankrupt tomorrow, then bonds will sell off and that's a bad thing. But if the US is entering a once a century economic boom, then bonds will also sell off and that's a good thing. So bond yields can go up and the prices go down for good and bad reasons. And that just is so mind bending for a lot of people that it can cause problems.

5:37And also it kind of depends who you are, right? So for some countries, if your economic growth is collapsing, that means that your growth weakens because it means that you're in a worse position to pay back your bonds, which might not be in your own currency. But for other countries, if your growth collapses, that probably means that interest rates are going to fall in response and your bonds climb and your borrowing costs fall. So it is all a little bit upside down and back to front. And I think that's one of the things that bothers people. But also, even if you are a specialist in this stuff, you know, you and I are in the same boat here.

6:12We talk to investors and analysts all the time. And there's been quite a sizable decline in government bond prices over the whole of the course of this year, pretty much. And you ask five different people why this is going on and you get like 10 different answers. People just cannot agree what the main driver is here. So from talking to people, what are you settling on as an explanation? It's like an inkblot test. people see what they want. Some people say, oh, it's government borrowing gone amok. Some people think it's the global economy is booming. So why would you want to keep money in bond market?

6:44Just put all the money in AI stocks. Other people will say, and I think this is the stronger argument, that actually it's the war in Iran that is pushing up inflation globally, that we already had a bit of a festering inflation problem after COVID. We hadn't got inflation all the way down to that magic 2 % that most central banks target. And this war and the energy shock that has flowed from it is now kind of filtering into prices of a lot of things. And inflation, Katie, you and I know this, is the nemesis of the bond market. Income, fixed income, it just bloody hates inflation. And there's no getting around that.

7:25There is no getting around it. But yes, so Iran has been a big problem for bond markets because it pushes up oil prices, that pushes up inflation and eats away at bonds and pushes up borrowing costs. But really, you can trace the turn, like the big historic turn in bond markets back a little bit further than that, because you saw like borrowing costs just fell and fell and fell and fell pretty much globally for like decades. different people try to take credit for the sort of 40-year bull run that we saw in bonds and the gradual decline in borrowing costs and central banks are like oh yes that's because we're so clever and we're so good at bringing down inflation the competing school of thought is China just became like a thing in the global economy pulled down inflation for everyone we all owe China a big debt of gratitude and then I feel like Covid was the line in the sand COVID was the point at which it was like, oh, inflation is a thing again, like for first real time since the 70s.

8:23Bonds hate inflation. I'm going to sell my bonds. And ever since then, there's been this cloud over the market. Yeah, no, we used to talk that post-financial crisis period of the 2010s is the new normal was what people talked about. It was like low growth, low inflation, low interest rates and therefore low bond yields as well. But I think and we try to get a bit of inflation. We try a bit of growth. Central banks were cranking out money all the time to try and get stuff going, but they couldn't do it. But it was almost like a ketchup bottle that finally became not just like the whole cork, the top fell off it after COVID.

9:02And then we also have the war when Russia invaded Ukraine. that suddenly kind of just sent prices for energy, agricultural stuff, grain spiraling. And I think that has been the big issue. But I do think it's a regime change that we've gone through in the financial system. It's one of the big markers of the way that the world has changed, I think, since 2020 is right there in the bond market. I actually think that the sheer amount of debt that we're borrowing, look, it is magnificently large in absolute dollar terms. Give us some numbers. What are we talking? So what's the US? It's like budget deficit 8 % of GDP this year.

9:41I mean, that's like bigger than World War II. Yeah, yeah. The US is... Like, it's huge. And the US national debt famously jumped over$40 trillion earlier this year. And lots and lots of developed economies have got more debt than they have the size of their economy. So that kind of leads me to we've seen some, you know, mini blow ups this year. We've seen U.S. borrowing costs get quite spicy. That bond market has been under a lot of pressure considering it's the U.S. The French government bond market, and we spoke to Ian Smith about this on this very podcast a little while ago, that's been feeling the heat from general France being France as usual.

10:27Lots and lots of spending, very difficult to get a plan to bring that spending down. How close to midnight do you think we are on a proper reckoning in the bond markets where you get a big explosion higher in borrowing costs that really forces governments to stop spending all this money? I actually think we are a long way from midnight because I actually don't think like the size of the debt, although scary, is the biggest driver. Actually, we've seen borrowing costs fell for 40 years, even as debt spiraled higher. So actually, I think that relationship, it can matter, especially if you're a poor developing country.

11:02But for most big countries that we say are monetarily sovereign in that they borrow money and they use their own currency, essentially. So in France, to a large extent, they do kind of control the euro. It is their currency. But the United States, the UK, I actually think we are not at risk of what I think of like the acute debt crisis. And there can be self-inflicted gaping wounds like the blow up in 2022 in the UK. The US has had a few little technical snafus like caused by like weird hedge funds blowing up and stuff like that. But broadly speaking, look, these are countries that can literally create the money that they owe.

11:42If they really have to. Yeah, if they really have to. So I think actually that is we're far away. But that's kind of maybe make something else more dangerous. that an acute debt crisis in the way we've typically seen in like a Greece or Argentina or Venezuela or whatever, that just won't happen or play out in the same way in other countries. But that makes us more vulnerable without that stress, without that kind of fearful or fear for a crisis. It makes us more vulnerable to a chronic debt crisis that plays out super slowly over like 20 years maybe. and like France is kind of maybe in their foothills maybe it's at the latter stages who knows France is very French it's both the best thing about France but also the worst thing that like they will have a hard time cutting their budget deficit but like fundamentally like they just pay a lot to borrow but they don't pay extraordinary amounts they're not Iraq right so they'll just pay a bit more and they'll eat up more and more of the budget in the UK and the US and Germany and Italy until we wake up sometime in 20 years time and realize that it's not just the fact that we're spending more money on just servicing our debts than we are on defense but like on health care infrastructure education all these things because we've never really made those harder choices but i think that's a slow moving amble kind of subconscious amble towards midnight rather than this kind of classic oh my god the house is on fire we need to get out right right right Right.

13:14Right. Speaking of hard choices, just quickly, like what some people often say about the bond market is that, you know, who the hell are these bond investors to boss governments around? Governments should just do what they want and bond markets should just suck it up. Why is that hard to achieve and a silly thing to say? Well, because, I mean, if I borrow money from somebody, you know, and I need to borrow money for them to eat, well, they do have a bit of influence. They might say, well, look, you can have some money to eat. Just don't spend it on candy. Don't spend it on jet skis. And the bond market is basically lending money to you all the time.

13:53I mean, weird enough, like Norway has a bond market. Norway doesn't need to borrow, but we have a bond market because it's kind of, it's so essential to a modern financial system and how it functions. But we don't need to borrow. The bond market can't boss around Norway because there's more money than we have debt. the UK, the US, France, other countries that kind of depend on somebody lending you money do kind of see them somehow a power. And the only power is that they can charge more or stop lending to you entirely. Yeah. So, yeah. You can't hold a gun to people's heads and force them to buy your bonds.

14:27And you can try and artificially hold down your borrowing costs, but it will go wrong at some point. Well, you can do sorts of things. I mean, the kind of the legal equipment, like these are countries that can pass laws. They can just pass a law and says everybody in the UK, all the banks have to buy more gilts. All the pension plans in the US have to buy more treasuries. It's kind of, they can force a lot, but to a certain extent you can't take it too far and eventually the bond market will exact its vengeance. And it tends to be quite nasty when it does. Look at me, I'm the captain now. That's what happens every time.

15:01Robin, thank you so much. We're going to have to come back in just one second with Longshot.

15:12All right, 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. Robin Wigglesworth all the way over there in Oslo. What are you saying? I think I'm going to go long witches, actually. You mentioned that I'm the co-host of our financial history show, The Story of Money. And we've got an episode going out ahead of Halloween that looks at the economic causes of the big witch trials in Europe in the 15th and 16th century. Because outrageously, it is incredible. Like, I know it's a joke that kind of seeing money or economics behind every stone.

15:50But really, it does look like maybe it was there was a mini ice age around then. So crops were failing, people were dying, and then people look for something to blame. And they blamed women. What a surprise. It's always our fault. So in a very small, pathetically useless way of his historically redressing things, I'm going to go long witches. And there were probably just mostly widowed women that the local town wanted an excuse to throw on a pyre. Yeah. So listeners, you've heard Robin promoting his podcast and promoting his book. I need you to know that he thinks that he doesn't talk about himself or do much self-promotion.

16:30I do only what is necessary and I take a very long bath after every single time to make myself feel slightly less unclean I don't want to think about that I am short yachts I read with enormous sadness on our pages that Europe's super rich are running out of space in marinas to park their yachts the story from our colleague Ivan Levingstone quoted a yacht consultant who told us Unfortunately, there are some people in this industry that have come into a lot of money really quickly and perhaps they don't quite get the nuances of decorum required. Oh, wow. So the old money yacht people are resenting the new money yacht people.

17:12Oh, wow. So this devastating news is enough for me to put on hold my plans to purchase a super yacht. Yeah, I mean, economic anxiety is real, Katie. The struggle is so real, Wigger. Yeah, I know, I know. I also know the pain of finding somewhere to dock my super yacht every summer. People need to get a grip. Robin, thanks so much. But listeners, we'll be back in a couple of days. So tune in then.

17:56Thank you.

18:26The new episode of The Next Five podcast is all about sovereignty, data and control. Charlie Giancarlo at Everpure joins me. You always get a very embarrassed response if you ask them if they know where all their data is. As does Professor Sana Karaghani. There isn't any modern AI system that's entirely sovereign. And Claire Schramm-Fergus at Lloyd's Banking Group. We really need to design for safety rather than bolting it on at the end. Listen to The Next Five wherever you get your podcasts. Enjoy. For years, credit scores were generated with just a snapshot, a snapshot that left millions of people out of the picture.

19:02So VantageScore is modernizing the credit score. VantageScore uses 400 % more credit report and alternative data than legacy models, bringing more people into the credit economy, like 5 million more mortgage-eligible people. Banks win and francs win, lenders win, and so do lenders. When you build credit scores the right way, everybody wins. Get started at VantageScore.com.