Bond Watch: has Jeremy Hunt tamed the ‘bond vigilantes’?

Sam Benstead runs through the most important news stories of the week for bond investors.

Welcome to interactive investor’s ‘Bond Watch’ series, covering the latest market and economic news – as well as analysis – that is relevant to bond investors.

Our goal is to make the notoriously complicated world of bond investing simpler, by analysing the week’s most important news and distilling it into a short, useful and accessible article for DIY investors.

Here’s what you need to know this week.

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Chancellor change has desired impact

Jeremy Hunt was brought in as chancellor a week ago to re-establish fiscal prudence for the Conservative Party following a splurge of unfunded tax cuts by his predecessor Kwasi Kwarteng.

He U-turned on nearly all of Kwarteng’s policies. The basic rate of income tax will now stay at 20% (rather than fall to 19%) and corporation tax will rise to 25% from 19%. The only policies to survive were the cuts to stamp duty, and the decrease in National Insurance tax by 1.25 percentage points.

Schroders, the fund group, calculates that the policy reversals announced so far could reduce government borrowing by just under £100 billion, or 4% of GDP by 2026-27.

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Bond markets reacted as hoped, with investors buying UK government bonds (gilts), therefore pushing prices up and yields down. The yield on the 10-year gilt is now just under 4%, compared with 4.5% before the intervention.

With the resignation of Liz Truss, Rishi Sunak is the favourite to become the next prime minister. He would back Hunt's approach to managing spending and reassure markets. Penny Mordaunt would have a similar effect, but if Boris Johnson became prime minister again then investors may be spooked once more, which would send gilt yields higher. 

Some investors took advantage of the spike in yields to add to their gilt positions. These included Duncan MacInnes, manager of the Ruffer Investment Company, as well as Peter Spiller, manager of Capital Gearing investment trust.

interactive investor customers also reacted, with direct bond trades up 700% in the first two weeks of October compared with the year before.

Bond vigilantes tamed – for now

Kwarteng’s mini-budget brought the return of “bond vigilantes”, a term used to describe bond investors who force governments to change their policies.

Governments rely on the bond market to fund everything they do. If bond investors don’t like their plans then they sell their debt, pushing up the cost of borrowing and therefore often forcing the government to change their plans.

By crashing the gilt market in protest at the extra spending, the bond market had a big role in removing Kwarteng and forcing the prime minister to appoint a more conservative treasury boss. Bond yields then fell in response to rising prices.

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Other examples of bond market tantrums affecting politics include the 2009 eurozone crisis when investors pushed up the borrowing costs of struggling Portugal, Ireland, Italy, Greece and Spain, and in the early 1990s in America when the Clinton administration increased spending.

James Carville, an adviser to Bill Clinton at the time, said: “I used to think that if there was reincarnation, I wanted to come back as the president or the pope or as a .400 baseball hitter. But now I would like to come back as the bond market. You can intimidate everybody.”

US bonds now yield more than UK bonds

The change in government policy and the positive response from UK bond investors means that gilts now yield less than US government bonds, known as treasuries.

The US 10-year bond now yields 4.15% compared with about 3.9% a week ago, while the UK 10-year bond yield has moved from 4.5% two weeks ago to 3.9% today.

The worsening sentiment towards US government debt is due to expectations that inflation is becoming more ingrained, and therefore interest rates will have to increase more than markets expected to bring prices down.

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Jim Reid, head of global fundamental credit strategy at Deutsche Bank, said: “The honeymoon rally of the last few days petered out, with treasury yields hitting multi-year highs as investors turned their focus back to central banks and how fast they’ll hike rates.

“All the big central banks are deciding policy over the next couple of weeks, so it’s not surprising that’s happening, but sentiment wasn’t helped either by further inflation surprises from the UK and Canada for September, which echoed what we’d already seen from the US last week. and added to the sense that the hiking cycle will be extended.”