Why Bonds Are Britain’s New Economic Battleground | Hamish McRae

Bond markets have endured another uneasy week, yet fixed-interest securities rarely command the same attention as shares.

Moderna’s near-doubling after positive drug-trial results makes a far more striking headline than the Government being forced to borrow for ten years at above 5 per cent.

Rationally, however, the second development is much more significant.

Moderna’s stock remains below half the level reached in 2021, when the company launched its pioneering Covid-19 vaccine.

By contrast, the Government last week paid the highest interest rate on a ten-year gilt issue since 2007.

Most people will know that US shares are trading close to record highs, despite a recent retreat in some technology stocks. UK shares are not far behind.

What many may have missed, unless they regularly track financial markets, is the bloodbath that has unfolded in long-dated bonds.

Consider 30-year gilts, the UK Government’s long-term bonds. Their yield has climbed to 5.8 per cent, its highest level since 1998. Anyone who bought them in 2020, when yields were below 1 per cent, would have lost two-thirds of their money, because bond yields and prices move in opposite directions.

Their value has collapsed as the Government continues to accumulate debt. So much for the conventional assumption that bonds are safe while shares are dangerous.

The sharp rise in yields has alarmed policymakers. Britain has little room to manoeuvre because global investors have limited confidence in its Government. In the US, however, officials are attempting to bring down borrowing costs at the long end of the market.

On Wednesday, US Treasury Secretary Scott Bessent stepped into the market and bought 30-year government debt, pushing prices higher and yields lower. The move came as a surprise and briefly worked, but by Friday yields had largely returned to their starting point. Above 5.25 per cent, they remain at their highest level since 2007.

The episode offers a familiar warning: attempts by governments or central banks to control markets rarely succeed for long. A government can buy back its debt, but the obvious question is where the money will come from.

The US Treasury has cash reserves available, but it will ultimately need to borrow again, probably by issuing more short-term debt with maturities of three or six months.

There have been successful interventions, particularly in currency markets.

The clearest example came in 1985, when the dollar’s surge against other currencies made American exports prohibitively expensive and contributed to a huge US trade deficit, especially with Japan and Germany.

Central bank governors from the US, UK, Japan, France and West Germany gathered at New York’s Plaza Hotel. They agreed that the dollar was overvalued and intervened by selling it while buying other currencies in an effort to drive it lower.

The announcement was completely unexpected. The dollar fell, while the German mark and Japanese yen strengthened, helping to avert the threat of a trade war.

In retrospect, the intervention succeeded largely because markets already believed the dollar was due for a decline. The timing was excellent, but the agreement mainly accelerated a move that was likely to happen anyway.

The most notorious example of intervention failing was Britain’s futile attempt to defend sterling in 1992, before the pound was forced out of the European Exchange Rate Mechanism.

We spent billions of our gold and foreign exchange reserves trying to keep sterling linked to the German mark, French franc and so on. George Soros, ‘the man who broke the Bank of England’, was one of the main beneficiaries, making £1billion betting against the pound.

Ultimately, what would surely bring down bond yields would be a combination of governments cutting their deficits and the central banks getting inflation down. Neither looks likely right now.

There’s huge pressure to raise money from the private sector to fund the data centres that will drive the artificial intelligence revolution, and that has clashed with governments around the world having to find more money for everything from funding services for their ageing populations to rebuilding their military.

As for inflation, the pressure there is rising too. I think we’re in the early stages of a big battle between governments desperate to raise funds and investors ever more sceptical of their ability to control spending and cut deficits.

I back the markets. Expect bond yields to rise quite a lot further before they come back down.