A warning from global bond markets

A global selloff of government bonds sent benchmark yields to multi-decade highs this week as investors fret over inflation and fiscal credibility.

Long-term bond yields in the US and the UK are at peaks not seen since the Global Financial Crisis. Borrowing costs in Germany are at a 15-year high. The Japanese benchmark bond yield is on the brink of hitting 3% for the first time since the mid-1990s.

Structural factors are playing a part: massive debt issuance by AI hyperscalers means fewer buyers for government bonds. But this is largely about “growing concern on the fiscal trajectories of many countries where growth is subpar, inflation sticky . . . and levers to improve the fiscal situation are not obvious”, Vincent Mortier, chief investment officer at Amundi, Europe’s largest asset manager, told the FT. 

A self-reinforcing cycle

We were in a similar place this time last year: "The coordinated surge in global long-dated bond yields is a problem because it creates a self-reinforcing cycle," I wrote at the time. "The higher yields climb, the less sustainable government debt appears – which in turn pushes yields even higher. Credibility is the issue – once lost, it’s slow to return, and some governments don’t have the luxury of waiting."

Back then, Chancellor Rachel Reeves was scrambling for solutions to fill a £30 billion fiscal black hole ahead of the Autumn budget. The government's finances are in a marginally better place now, but current Chancellor John Healey will no doubt be aware of the parallels – economists estimate his fiscal headroom sits at just £10 billion and Prime Minister Andy Burnham has made some expensive pledges.

"A so-called Smorgasbord of taxes on assets and wealth is likely to be Burnham’s preferred method of payment for his plans" in October, Knight Frank's Tom Bill wrote on Monday. "Given the bond market won’t permit a government spending spree, Labour backbenchers won’t sanction meaningful spending cuts, and the Labour manifesto ruled out income tax, VAT or national insurance rises, the approach increasingly looks like the default option."

Indeed – the likes of former Bank of England Governor Lord Mervyn King have criticised successive governments for their “back of a fag packet”, reactive tinkering with tax policy. It adds further layers to an already complex system, does little for the UK’s fiscal credibility and leaves the government vulnerable to jitters in the bond market. Much broader reform is needed, though sadly not imminent.

Energy prices

Rising energy prices pushed the UK's annual rate of inflation to 2.9% in July, up from 2.6% the previous month, according to official figures published this morning. That's in-line with economists' expectations and is unlikely to have any meaningful impact on mortgage pricing. 

The Bank of England expects inflation to rise above 3% later this year as the conflict in the Middle East pushes up gas and electricity prices. The Monetary Policy Committee (MPC) is divided between those who believe a weakening jobs market will be enough to offset the inflationary pressure, and those who would rather raise rates than wait to find out.

Still, nearly 90% of economists polled by Reuters, 56 of 64, expect the MPC to leave rates unchanged at 3.75% this year, up from 83% last month. Six expected a hike by then, and another two forecast a cut. The poll was conducted August 13-18.

No economist forecast a rate change at the next MPC meeting in September. Financial markets are still pricing in one quarter-point rate rise by year-end.

Asking prices

The average asking price of a newly-listed property in great Britain dropped by 2.0% this month to £364,999, according to Rightmove data. That's the worst performing August since 2018. 

Summer sellers are cutting prices due to the quieter holiday period, and there are more homes for sale in August than at this time of year since 2014, the company said. In London, where asking prices fell 3.1%, buyers have the largest choice of homes available since 2010. 

In other news...

Landsec lines up £500m bid to buy Gateshead Metrocentre (Times), and finally, the new AI super-rich are reshaping the market for jets, yachts and cars (FT).