Outrun the vigilantes
Rising bond yields should spur governments to go for growth
The bond sell-off may partly reflect America’s productivity boom
Brutal bond sell-offs are not what you expect after interest-rate cuts.
But since the Federal Reserve started reducing its rates in September the yield on America’s ten-year Treasury has risen by about a percentage point, to 4.7%.
A global repricing has followed. In Britain yields have climbed to about where they were after Liz Truss’s disastrous “mini-budget” in 2022, despite interest-rate cuts and austere government rhetoric.
Yields are up in the euro zone, Canada and across emerging markets.
The striking exception is China, where investors are worried about growth.
Almost everywhere else indebted governments, companies and homeowners must grapple with the rising cost of capital.
The bad news is that bond investors are looking aghast at genuine economic uncertainty.
The good news is that the uncertainty is two-sided, and on one of those sides higher yields are a sign of a healthier economy.
Though they are painful now, there might yet be a reason to cheer them.
The first headache for investors is inflation.
Globally it has fallen from an annual rate of 10.4% in late 2022 to 4.4% today, leading to much backslapping among central bankers.
But in many places it is proving hard to get down to the official target, usually 2%.
That has reduced confidence that deep interest-rate cuts are coming.
Non-farm payrolls in America rose by over a quarter of a million workers in December, feeding fears that the economy is still too hot.
In Britain growth is lacklustre, but surveys show inflation expectations creeping up.
The oil price has risen by over 10% since Christmas, to around $80 a barrel, in part because of American sanctions on Iran.
Donald Trump’s agenda could give prices another boost.
He threatens tariffs that dwarf those implemented in his first term.
It is unclear how much this is a negotiating ploy, but his pledge on January 14th to establish an “external revenue service” suggests he wants permanently high tariff revenues.
If his administration somehow manages to deport millions of illegal migrants, there will be shortages in the labour market.
Last time Mr Trump was in office inflation was quiescent, but today central bankers are on a hair trigger: his policies are more than enough to scare bond traders.
The last big worry is mounting public debts.
Finance ministers have been grappling with ageing societies, the pressure to spend more on defence and the green-energy transition—plus populist resistance to spending cuts.
Budget rows have helped force Justin Trudeau to step down as head of his party in Canada and caused chaos in France.
A big fiscal fight looms in America, where Mr Trump wants to cut taxes, even though the deficit is already a gaping 6.9% of GDP.
Rising yields should discipline politicians to shrink their deficits.
But the danger today is that higher debt-interest costs push them further into the red.
The combined debt-to-GDP ratio among big rich economies is nearing 100%, a level at which a percentage-point increase in bond yields eventually drains the public coffers by 1% of GDP annually, or more than half of most European defence budgets.
If higher interest rates and bond yields simply bring about bigger deficits, the economy gets a stimulus, and central banks can lose control of inflation.
It is an alarming prospect.
Yet for any borrower, the cost of debt is only one side of the equation.
Growth in income also matters.
In America GDP has soared, thanks in part to labour productivity: output per hour worked has risen 10% in five years.
Optimists think things will soon get better still, as artificial intelligence (AI) supercharges the labour force.
America’s stockmarket has long reflected such an expectation.
And although it has wobbled as bond yields have risen—the S&P 500 index is now not much higher than when Mr Trump won the election—stocks are still astonishingly expensive.
Growth and interest rates are tightly linked. Just as Chinese yields have been falling in anticipation of a protracted economic malaise, so America’s might be rising partly in expectation of accelerating productivity.
Companies’ surging investment in AI is running at a pace of about $55bn a year.
Once in full swing, the dotcom boom led to extra investment worth 1.5% of American GDP, according to Goldman Sachs, a bank.
More demand for capital mechanically increases yields even if the investments end up being a disappointment.
But outside America, higher growth is possible too.
Sclerotic economies must make their labour markets more flexible and avoid excessive regulations that hinder the adoption of AI.
They should avoid responding to protectionism with their own tariffs, and deepen their own economic integration to offset Mr Trump’s trade war.
And they should avoid foolish industrial policies which suck up capital only to waste it.
High yields could portend disaster.
But if they force governments to try to match America’s fast growth then they might yet bring about some good.
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