We are all ‘in hock to the bond market’
I honestly get really aggravated when I hear politicians on the left of the political spectrum argue that we should stop paying attention to bond markets and rather spend more to help people.
Many politicians who lean left in their political views argue against focusing on bond markets and instead advocate for increasing spending to aid the population. This tendency appears particularly pronounced among left-wing politicians in the UK, so much so that even the New York Times felt compelled to explain this concept to its American readers.
Previous work by the author revealed a study which showed how the UK finds itself in a similar economic situation to Italy, thanks to a previous Prime Minister who chose to pursue a path of unfunded deficit spending. Ironically, this was a policy undertaken by a right-leaning politician, highlighting that economic ignorance is not exclusive to any political camp.
Responsible politicians should be aware that their spending decisions can influence the bond market and consequently, the interest rates a nation must pay to finance its deficit. While the author is unaware of any recent study specifically examining the connection between UK budget deficits and Gilt yields, a study conducted by the Federal Reserve Board on the US markets provides insight.
They discovered that a one percentage point increase in the US debt-to-GDP ratio (although this is not an actual increase, rather market consensus estimates suffice) leads to a rise in the expected 10-year Treasury yield over the next five years by approximately 4 basis points. For reference, if the US Treasury's refinancing costs were to increase by 4 basis points across the board, it would result in a long-term increase in interest payments of $14 billion.
However, the burden of higher borrowing costs would not be evenly distributed. The term premium for long-term Treasuries would rise by about 2 basis points, and the risk-free rate would increase by an additional 2 basis points. This is not an isolated phenomenon, as growing evidence suggests that bond investors are demanding a higher risk premium on bonds issued by countries with significant debt levels.
The US, while benefitting from the privilege of issuing the world's reserve currency, which to some extent protects it from these effects, faced a situation recently where it had to concede that long-term Treasury yields were too high, leading the Treasury to refinance maturing debt at shorter maturities in order to keep costs manageable. This situation mirrors that of Greece in 2011.
Written by urgent.news from Klement on Investing's reporting — not their text. Machine-written — may contain errors; check the original before relying on it.
