Central Bank Raises Alarm Over Rising Government Debt Impacting Bonds
The bond market is facing pressure due to escalating government debt levels and relaxed fiscal policies, even as optimism persists in US and global equities, a prominent central banking entity has cautioned.
The Bank for International Settlements (BIS), often referred to as the “central bank of central banks”, has noted a resurgence of fiscal apprehensions in financial markets following the election of Donald Trump and the dissolution of France’s minority administration, which has rekindled worries about investors financing increasing deficits amid potential inflation.
In recent weeks, sovereign bonds in significant economies such as the US, UK, and parts of the eurozone have depreciated in value despite a record surge in US stock prices triggered by the November presidential election and China’s economic stimulus strategies.
The BIS emphasized that while there is hope for an economic boost in the world’s largest economy, there are growing concerns regarding the fiscal sustainability of the US and the inability of affluent nations to curb their spending. The institute pointed to the October budget revealed by Labour as a specific instance of fiscal easing, where the government announced a relaxation of fiscal constraints and increased borrowing.
“Emerging concerns regarding fiscal stances in various jurisdictions have surfaced as another significant influencer in the bond markets,” stated the BIS in its latest quarterly evaluation.
“Re-emerging worries about fiscal conditions in some areas, along with quantitative tightening in others, have contributed to increased pressure on yields. Rising term premiums, negative swap spreads, and widening sovereign spreads indicate that investors are seeking higher compensation to accommodate the surge in debt supply.”
The yield on 10-year US Treasuries, which reflects government borrowing expenses, has jumped from 3.9 percent at the beginning of the year to 4.2 percent. Similarly, the yield on UK gilts rose from 3.5 percent to 4.3 percent, while in Germany, it increased from 1.9 percent to 2.1 percent, serving as the benchmark for the eurozone.
An increase in government bond issuance elevates the available supply, leading to price declines and higher borrowing costs unless met by improved demand from bondholders. Anticipated inflation concerns also exert downward pressure on bonds, which could result in sustained high interest rates.
The BIS observed notable imbalances in supply and demand within the US Treasury market, where there has been “lukewarm interest in absorbing the supply of government debt.”
In France, the gap between French government borrowing costs and those of Germany reached its widest since the eurozone’s sovereign debt crisis, following the minority government’s failure to implement significant tax increases and spending cuts planned for the upcoming year.
France’s budget deficit stands at 6.2 percent of GDP, one of the highest rates within the eurozone, while the US deficit is at 6 percent and may widen to 7 percent in the next two years as a consequence of proposed Republican tax cuts, as per estimates.
Market analysts are beginning to sound alarms about the return of “bond vigilantes,” investors who raise a nation’s borrowing costs in response to lax fiscal policies, reminiscent of the turmoil seen during the UK’s mini-budget sell-off in September 2022.
Pimco, one of the largest bond funds globally, indicated it is “less inclined to lend to the US government” for the long term amid concerns about the nation’s future debt stability.
According to Marc Seidner from Pimco, “We have been decreasing our allocations to longer-dated bonds, which we perceive as relatively less attractive. Over time, this kind of investor behavior could act as a fiscal discipline mechanism on governments through demands for higher compensation.”
Analysts at Carmignac, an asset management firm, caution that high-spending populist administrations emerging in various developed nations “will test the resolve of bond vigilantes.”
“Should these influential investors begin selling in protest against unsustainable fiscal policies, the resulting influx of bonds would increase borrowing costs and weaken the currency, generating a detrimental feedback loop impacting inflation and the overall economy.”
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