TO label a country, an emerging market should cause excitement. Such economies are said to be on the path of “development”: integrated into the global financial and trading systems, growing stably, and offering high incomes to their citizens. Since they are not quite there yet, they have to pay their creditors a premium. However, the label also applies to countries where politics has become a bit too exciting to trust. Think of sticky customers like Argentina, whose profligacy has made it a serial defaulter on its sovereign debt, or Turkey, where interest rates remain low even when inflation tops 80%.
A growing cohort of blue-chip economies are now referred to in similar terms — and the comparison is not meant to be flattering. Britain made a spectacular entry into this financial purgatory in late September when it unveiled plans for huge unfunded tax cuts, sending the pound sterling plummeting. It’s far from the only wealthy country where government bonds have become unusually exciting. Worse, the dullness may not return for some time.
Some of the thrill has little to do with government policies. This year, the rich world’s central banks have repeatedly raised interest rates, reducing the present value of the coupons paid out on bonds and lowering their prices. Nobody knows how high interest rates will go and how long they will stay there. The bond markets are nervous across the board. That MOVE Index, which measures how clueless bond investors are thinking about the future, is nearly double the average in the five years to February 2020, when the pandemic first shocked markets.
Monetary policy surprises are nothing new for long- remembered developed market bond investors (think the colorful 1980s). Instead, today’s tension revolves around two novel forms of uncertainty: whether rich-world governments can afford the massive volume of debt they issue, and whether the market can absorb it.
Start with the amount of debt. Most rich world governments already have plenty of it, having spent the last 15 years bailing out their citizens and businesses from successive crises. As financial panics gripped banks, lockdowns forced businesses to close and huge energy bills threatened to freeze households, the reflex was to allocate public money. Fiscal liberality remains in vogue: America is dwarfing green industries and there are no plans to end Europe’s lavish energy subsidies.
This habit of big government emerged in years when rock-bottom interest rates kept borrowing costs low and rich-world creditors lenient. Now, interest bills are rising, exposing developed market governments’ spending plans to a scrutiny formerly reserved for their emerging market counterparts. Moody’s Analytics, a research firm, predicts that the US Treasury will spend more on interest payments than on defense by the middle of this decade. The UK’s Office for Budget Responsibility, a watchdog, estimates that its government will pay out £120bn ($146bn) in interest this fiscal year – the equivalent of 80% of the budget for England’s National Health Service.
For about a decade, investors weren’t the only ones buying the debt that funded rich-world governments. In the 2010s and up to the last few months, much of it was purchased by central banks under quantitative easing programs. Now those buyers are disappearing, leaving bond investors to soak up the surplus.
Hence the second big unknown: Are bond markets deep enough to handle the coming tide? In fiscal 2023, the US Treasury may need to borrow as much as $2 trillion from the market – nearly double what it borrowed from investors annually in the two years before the pandemic, and four times the average for the five years prior. Citigroup, a bank, expects the UK government to seek twice as much net liquidity from the bond market in the next fiscal year as it has in the past eight years combined.
If proposed by a Latin American government, such an issuance plan would have already pushed bond yields higher. Rich countries have long enjoyed far more freedom and escaped the full price of tax incontinence. Now, however, they are looking from investors to buy huge amounts of debt amid rising borrowing costs and a bleak economic outlook. The bond market drama could have many more installments.
Read more from Buttonwood, our financial markets columnist:
Has Private Equity Avoided the Crash in Asset Prices? (December 1)
How crypto goes to zero (November 24)
The persistence of ESG investing (November 17)
Sign up for more expert analysis of the biggest stories in business, finance and markets talks about moneyour weekly newsletter for subscribers only.
