Yves here. With too much Trump-generated furor, we’ve managed to skip over a potentially important development, that of a possible slow-motion currency crisis/bond market temper tantrum in the UK. To give a sense of sentiment, this is the landing page of Bloomberg’s UK site. Bloomberg generally does not run headlines that take up the the full width of the page:
And from a widely-read Bloomberg story yesterday, Britain’s Bond Crisis Invokes Memory of 1976 Crisis:1
That’s the analysis of former Bank of England rate-setter Martin Weale, who said the Labour government may have to resort to austerity to reassure markets that it will address the UK’s escalating debt burden if sentiment does not change….
Over the past few days, long term UK borrowing costs have soared and the pound has fallen – a rare combination that can signal investors have lost faith in the government’s ability to keep a lid on the national debt and control inflation.
Typically, higher yields would support a currency, but Thursday morning sterling sunk below $1.23 to its lowest level since November 2023, having started the year above $1.25. Still, the currency’s latest struggles are less severe than in September 2022, when it crashed from close to $1.17 to below $1.07 in a couple of weeks.
And Britain’s market troubles are not an isolated case, coming amid a global selloff in bonds.
Nevertheless, Weale said the events echo the 1976 debt crisis “nightmare” that forced the government to ask the International Monetary Fund for a bailout…
Other economists and investors blamed the market moves on skepticism around Labour’s promise to fund a large increase in spending with fastest growth….
Almost half a century ago, Britain applied to the IMF for a $3.9 billion loan after large budget and trade deficits plunged the country into crisis. In return, the government agreed to IMF-imposed austerity. Britain is today running twin deficits again, and has been for many years.
Countering that view is Wolf Richter in “Bond Market Rout” in the UK (like in the US) Only Pushes the 10-Year Yield into Low End of Old Normal after Many Years of Interest Rate Repression. While that is true (as is the fact that mortgage rates in the US are in what was old normal before the crisis), nearly a full generation has passed under a low interest rate regime. Policy-makers acted as if it would continue and are having great difficulty recalibrating.
If you click through, while the tweet below provides another high level recap of the UK’s conundrum, El-Erian advocates hard core neoliberalism, as in austerity and crushing labor bargaining power. Um, decades of a lower dose of this sort of thing is what got the UK in this mess in the first place:
The UK continues to experience the unhelpful combination of higher yields and a weaker currency (see Bloomberg chart below on the British Pounds depreciation versus the Dollar over the last three months).
This combination, which historically has been more common in developing… pic.twitter.com/BUeazw7gzZ— Mohamed A. El-Erian (@elerianm) January 9, 2025
Additional detail:
The surge in UK debt costs threatens to wipe out Chancellor Rachel Reeves’ slim budget buffer and create instability ahead of an official fiscal update on March 26, as @lizzzburden reports https://t.co/Yt7WqggkQo pic.twitter.com/XIDd8ZlwXW
— Bloomberg TV (@BloombergTV) January 9, 2025
Admittedly, as with stagflation in the US in the 1970s, there’s no quick and easy remedy to higher energy prices, but that is intensifying an underlying not-wonderful set of fundamentals. High-ish inflation and borderline recession mean the usual MMT prescription of more net spending will simply generate more price increases, unless there are target areas where more spending would increase capacity enough so as to offset or even reverse inflationary effects. Recall that none other that the staunch neoliberal Larry Summers argued during the post crisis period of weak growth in the US, that spending on infrastructure would generate $3 for every $1 of outlay (obviously up to some limit). But the UK seems incapable of thinking in industrial policy terms to get itself out of its mess. While in theory the Labour claims that it will spend more to get higher growth signals a vague recognition that well-focused spending can indeed increase output, the Blairite Starmer Labour Party lacks the imagination and cred to devise and promote the needed ambitious programs.
By City A.M. Cross posted from OilPrice
- The pound sterling has fallen to its lowest level in more than a year, and UK government bond yields have reached their highest point since 2008.
- Investors are concerned about the UK’s fiscal outlook and the Bank of England’s ability to control inflation.
- The UK government’s bond issuance is expected to reach almost £300bn this year, which could put further pressure on the economy.
Pound sterling has continued to sell off this morning, and UK government bond yields have ticked higher as UK risk assets remain under pressure.
The pound fell below $1.23 against the dollar in early trade and is currently down 0.7 per cent against the dollar and 0.6 per cent against the euro.
Meanwhile, the domestically focused FTSE 250 index opened lower 0.6 per cent.
The day after 30-year government bond yields reached their highest this century, yesterday 10-year government yields jumped to 4.82 per cent, the highest since August 2008.
“We’re not at the Truss/Kwarteng stage just yet, but things are clearly on very shaky ground indeed,” said Michael Brown, senior research strategist at Pepperstone.
The pound also fell against all major currencies yesterday, plummeting more than one per cent versus the dollar to its lowest in more than a year at $1.238.
Derivatives point to the weakness in the pound continuing, with one-week sterling to dollar risk reversals falling to the most negative since early November, which implies puts trading at the biggest premium over calls since US election day.
“In part, this move is shadowing a rise in US bond yields, driven by signs of a still strong US economy alongside indications of persistent inflation that are prompting investors to review expectations for two rate cuts in the year ahead,” explained Lindsay James, investment strategist at Quilter Investors.
“Term premium, the additional yield investors demand for lending long-term money, has also been on the rise, with one factor being the pure level of uncertainty around the future path of inflation and the productive potential of the economy.”
With the UK enduring stickier inflation than most other developed economies, the Bank of England has been towing a more hawkish line than most of its peers.
However, a key factor continues to be the size of the bond sales by both the UK government and the Bank of England.
The government’s bond issuance is expected to reach almost £300bn this year, driving up yields even as the economy begins to show cracks.
Stagnant growth and the continuing gilt sell-off has “all but wiped out Chancellor Reeves’ fiscal headroom, which was already incredibly slim at around £10bn,” noted Brown.
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1 Did AI write this headline? A crisis cannot invoke. People or their institutions can. It should read “evokes”.
