What are UK bonds thinking?

0:05Pushkin. The UK's bond market is on fire. It's the 2022 guilts crisis all over again. Investors are recoiling in horror at the Labour government's policies. That, listeners, is what the more excitable bits of the internet would have you believe. Is it right, though? I'm going to give you a spoiler alert here and say no. Keep listening and we'll tell you what's actually going on. This is Unhedged, the markets and finance podcast from the Financial Times and Pushkin. I'm Katie Martin, a markets columnist here at FT Towers in London, busily trying to swat away the UK disaster tourists. And I'm joined by Robert Armstrong, president-elect of the Unhedged Newsletter and a pesky American who does at least know where the UK is, because he lived here for a bit.

0:55Rob, why can't we have nice things? Why can't we have a nice, quiet, civilised start to the year? Katie, I have no idea. I mean, it has something to do with the fact that the job of most important person in the world is changing hands. I think that's safe to say. So we're going to have a new president and that makes everything look less clear, more confusing, possibly more scary, all of that stuff. So that's in the air. I think you're right about that. Now, I mean, how much of an eye is the U.S. keeping on what's been going on in the U.K. market? Or would you benefit from a short refresher? Yeah, no, we would benefit.

1:40As you said, I did live in the U.K., but since leaving there a few years ago, I've forgotten everything about it. I'm not sure I could find it on a map, to be honest. It's a little island. So, look, the short version is U.K. government bonds, guilts to their friends, have had a bad start to the year, right? They've been falling pretty quickly. We've seen some pretty big falls, particularly at certain points last week. And obviously, the Labour government is only about sort of six months in office. It had a budget. We did all of its kind of spending plans in October. And, you know, the line on this that lots of people are taking is that what's happening now, this like drop in UK government bonds.

2:22I mean, I think like the 10 year yield has gone to the highest since 1998. And what is that? roughly what are we talking about? Oh, God, I can't remember now. I haven't got the number in front of me. So we're talking about 4.6%, 4.7%. U.S. yields, to be fair, are in the same, and right in that range. 4.77 for a U.S. 10-year, I think. You're just saying that because you've got it in front of you. I do. I make it my business to have numbers in front of me. This is the business we have chosen, Katie. We're in the numbers business. point is market no likey guilt also market no likey sterling so there's a slightly kind of oversized drop in uk government bonds and in sterling and that that sterling element tells you that there is a bit of a kind of pullback from uk risk here's my point though if you are one of these people who's got a chart in front of you showing you uk yields and us yields they go absolutely hand in hand.

3:24So to my mind, really what's happening here is that the U.S. bond market is moving. U.S. government bonds are weakening. That means that the yield is going up. So as usual, all roads lead back to the U.S. This is the only thing that matters. Rob, tell us, like, why are U.S. government bonds falling? First point, U.S. economy continues to astound. We had a jobs report on Friday that was much stronger than expected. And that is just the latest signal that the U.S. economy continues to grow above its long-term trend. So trend growth in the United States is somewhere between 1 % and 2%. Like if you look at the population and et cetera, all the usual economic inputs, that would be normal growth, sustainable growth in the United States.

4:16And we continue to chug along at between two and a half and three percent at a time when the rest of the world is not growing above trend. So the difference between the U.S. economy and the rest of the world continues to grow. Right. So that means the dollar pushes higher. That means the dollar pushes higher. Exactly. It means that it makes life difficult for the Federal Reserve in terms of it's going to be less able to keep cutting interest rates. So that's the biggie, right? We had, yes, there was the payrolls, the jobs report from the other day. But actually, if you go back a little bit further and you go to mid-December, you have the Federal Reserve saying, first of all, yeah, look, growth is looking pretty good.

4:55And second of all, not saying but hinting that, look, we've got this new guy coming into the White House. He's been there before. Some of his economic policies are kind of inflationary. So we would rather not keep cutting aggressively or promise lots more cuts to come if we don't know what Trump is going to do. Now, they didn't say that explicitly, but I would definitely add that to the list. Why are U.S. bond yields up, U.S. bond prices down is there is uncertainty about Trump policy. And as I've said on the show before, I think you have to discount pretty heavily the swarming army of so-called experts who have very concrete predictions about exactly what these policies will be and exactly what their economic implications will be.

5:45I think we, A, don't really know what the policies are going to be. That becomes clearer with each passing day. And it's also very hard to say exactly what, say, tariff policy is going to do for inflation. It's very context dependent. It depends on a million different things. It's just plain hard to predict. But what we do know is that the policy will change and things will happen then. so so you have to price in some uncertainty about things happening whatever they may be maybe line go up maybe line go down but things are going to happen and then other things are going to happen so this is expressed at least in part in something called the term premium yes so here's the thing right so like normally this is the thing that people in markets are kind of tearing themselves to bits about slightly.

6:37And that's infected the US market. And that is exactly what is pulling the UK market out of whack too, which is this idea that, you know, you look back a few decades, and every time you have central banks that are cutting interest rates, long term US yields fall. This is just like how the market works, that the bond price rises, the yield falls. This time, that is not happening. So you've got a Fed that since September has been cutting interest rates It's relatively hard. It's kind of hit pause a bit now, but its cut rate is pretty hard. All things being equal, that should tell you that the 10-year yield should be falling.

7:11And yet it has risen, something like a full percentage point. Somebody once used a metaphor with me. I should give them credit, but I don't remember who they are. So I'll just steal the idea. It's like a person walking a dog. And short-term rates and the Fed are the person. And they are holding the leash, right? Right. And so they can go one direction or the other and all else being equal, the dog should follow the dog being long term rates. But right now, the Fed slash person holding leash is pulling one direction and the dog is going the other direction. And people are like, what is that strange person struggling with his dog over there on the sidewalk?

7:56And just to go back, this goes back to the idea that people are demanding a little more return for locking in their money into a long term bond because they don't know what is going to happen. Yeah. Right. Yeah. And part of that is Trump, but only part. You could paint a few different reasons onto this kind of, you know, because markets are about stories and people tell themselves different stories about what's going on. And so none of these stories are necessarily right or wrong until proven otherwise. And so why are U.S. yields higher? Now, it could be that the market is saying, well, I think inflation is going to be higher in future.

8:36Fine. There's some problems with that argument, but OK. It could be that the market is saying the Fed should not have cut rates in the first place and it's going to have to backtrack. Biggie. It could be that the market is saying, oh, it's fiscal sustainability. This is the big debt crisis we've all been waiting for. It's all going to end in tears. The market is going to stop buying government bonds from everywhere in the world. Or it could be, so Paul Krugman, Nobel Prize winning economist, he called it an insanity premium on long term debt, which if memory serves, he was saying this is the market's way of saying we think some of what Krugman called the crazy policies of President-elect Trump are actually going to materialize and the market is nervous about them.

9:24So as you say, these are like things, these are like uncertain things. And so you've got just uncertainty layered on top of the market. Yes, I would take issue slightly with Krugman, because I think the fiscal explanation is important and real. And that is a bipartisan is an issue. Debt and deficits have gone bonkers since the beginning of the pandemic, and it is only natural that some of that would come home to roost in the price of US debt. And second, oh, I had such an important thing to say, second. Oh, right. And second, there's another issue here, which is that if you look back at history, the premium of long-term bonds over short-term bonds was actually larger than it is now.

10:16So as several people have pointed out, what may be happening here is not some crazy crisis, but actually a return to normal after we had a bond market that was anesthetized by central bank fiddling since the great financial crisis 15 years ago. So basically, after the great financial crisis, the Fed basically shot the bond market full of Novocain. And that is finally wearing off now. And the term premium can return to normal. The yield curve can get back into a normal pattern. All this stuff can happen because we're coming back to reality, which is that bonds, you get paid more for owning the long bond.

11:03Bonds have a price. They pay a real yield. All that stuff they didn't do for a long time. Yeah, yeah. But what it means is that, as you say, you don't have central banks buying loads of bonds themselves to support their monetary policy. That was a kind of zero interest rate period kind of phenomenon. But that means that you've just removed a safety net out from under the market, which means that if little things or big things go wrong, then you can get some quite violent moves in the market. And that, I think, is what's going on with the UK now. You know, we have got a new government. We are only a couple of years out of a hideous crisis that nearly brought the whole house down.

11:39And so this is what I was writing the other day. It just means that the UK is the ugliest horse in the glue factory. And when stuff goes wrong, as it has done now, UK is in your line of fire. Does that mean that the chancellor, Rachel Reeves, has done something wrong or that she should quit or that she should be forced out of office? I think that's a really hard argument to make. person. Oh, it's dumb, right? US yields have moved just as much. It's blaming her for a global phenomenon, right? Yeah. I don't even want to talk about that anymore. It's so silly. Okay, let me talk about something else silly, which is every time we've sort of touched on this, every time bond yields pick up, bond prices are falling, bond yields picking up for whatever reason, the bond vigilantes, they lift the lid off their coffins and like the undead, Yeah.

12:27The undead sheriffs of financial markets wake up and say, ah, there's going to be a huge crisis. Do you think there's going to be a huge bond market crisis this year? I mean, this thing is so scary when you think about it. The idea that there would be a really sharp, violent, pronounced rise in U.S. yields. I mean, I'm not talking about five. I'm talking, let's say we go to seven or something. People are like, we don't want to hold this paper anymore. The U.S. government is fiscally incompetent, we really got to get, we got to get like emerging markets paid to own US debt. I mean, the stock market crash that will cause will be unbelievable.

13:07But I think we have no way whatsoever of knowing when this event happens. And the reason I know we don't know is that people have been predicting it for 30 years and being wrong again and again. So I'm not going to jump on the wrong train and tell you that I know that it's this year, it's next year, whatever year. It has to happen. At some point, you can't have infinitely large U.S. deficits and infinitely large U.S. debt and have U.S. bonds paying only 5%. But no one knows when that point is. And it depends on all sorts of factors, like what are the alternatives for people to buy? What is the rest of the world doing?

13:48Economic growth, all that. So I give you a strong no prediction on that one. Cool. Well, you mentioned also like, you know, 5%. And I know it sounds silly how markets coalesce around round numbers. But my thinking around this is the minute you get the US 10-year yield hit 5%, the minute you get the UK 10-year yield hit 5%. I mean, come on. These are not countries that are going to default on their debts within that period of time. They print their own currency. They might print their way out of it. They might. print their way out they're not going to default so at that point once you hit five percent that's when a lot of buyers come out the woodwork and say look i'm not necessarily a huge fan of this asset class but five percent i'll take that you know and so that's when you start to get the bargain hunters coming in so look you know if if we are wrong and we really we're at the foothills of a huge like crisis in the bond markets in the uk and the us then we're going to look really really silly, but I don't, I really, I really can't see it.

14:49And you can, you can hold me to that when I'm wrong. Now, if I was a swivel eyed conspiracy theorist, if I was the sort of person who always thinks all these markets are giant scams controlled by the Masons and the Fed and the government, I would say we're just marking time until quantitative easing around the world starts again. So yeah, maybe buyers come in, but maybe we get up around five and the new Trump administration or the leadership, the Bank of England, whoever say, you know, that quantitative easing, you know, that was a pretty good idea. Rather than having their debt costs go through the roof, they're going to start buying bonds again, right?

15:31They're going to start monetizing the debt again. And that raises the specter of inflation and other things, but it does, it does, in theory, it does keep yields down. Yeah, kicks the can down the road, but it sure kicks it nice and hard. But yeah, look, my prediction for what it's worth is we don't go through 5%. We don't get above 5 % on either of these yields, because at that point, the bargain hunters come in. If I'm wrong, I'm wrong. Yeah, I'm with you. We'll be wrong together. I will share your prediction. So we can have a whole show about how dumb we are later. Well, yeah, listeners, you might want to tune in for more of that.

16:05But in the meantime, There's stuff coming that you're going to enjoy. In the meantime, we're going to be back in a sec with Long Short.

16:18Okie doke, it's Long Short, that part of the show where we go long, a thing we love, or short, a thing we hate. Rob, what do you love or hate? I am short, strulled, brug.

16:33Tell us, please. I don't know what that means. And I consider myself a person with a pretty large vocabulary. But this word appeared in Peter Thiel's recent editorial in the Financial Times, which may or may not have had insights in it, but was couched in the most unbelievable mediocre philosophy student jibber jabber. I have ever heard in my entire life. And as a person who spent like seven years in philosophy graduate school, I feel like I recognize. Game, recognize game. The presence of circular rhetorical nonsense. And I think the word, what was it? I can't even remember now. Strulled Brug.

17:28is just emblematic of a kind of writing that is best avoided if you don't happen to be a billionaire already and can write whatever you want. Yeah, so we care what Peter Thiel thinks because he's like part of that tech growth. A very important guy who's achieved a lot. Yeah. He's an important guy who's achieved a lot. He's made a metric ton of money. He's like one of these people who's close to President-elect Trump. And what he wants is a sort of post-apartheid South Africa style truth and reconciliation commission to find out who broke America. I don't even know it's that clear from that. Once you start using words like strulled brug, it's anybody's guess what you want.

18:09That's my point. Do you know what I think is going on here? You know how like these like very online guys spent a long time talking about the woke mind virus? You know, kind of, they think that like left-wing people have got like unsustainable views about like women and gender and all these other things. I think they are suffering from an outbreak of the edgelord bro mind virus. And I've got a name for it. It's Brovid. Brovid. You know how you say, Katie, you know how you say Brovid in German? Struhlbrug. Listeners, you heard this nonsense here first. You should absolutely read the Peter Thiel op-ed if you haven't read it already.

18:59It's quite the eye-opener. Do that, and then we'll be back in your ears on Thursday, so listen up then. Unhedged is produced by Jake Harper and edited by Brian Erstad. Our executive producer is Jacob Goldstein. We had additional help from Topher Forges. Cheryl Brumley is the FT's Global Head of Audio. Special thanks to Laura Clark, Alistair Mackey, Greta Cohn and Natalie Sadler. FT Premium subscribers can get the Unhedged newsletter for free. A 30-day free trial is available to everyone else. Just go to ft.com slash unhedged offer. I'm Katie Martin. Thanks for listening.

19:52We'll be right back.