The Bond Market & Politics
I have a strange obsession with gilt yields – and what’s more, I think my readers should too.
Most people reasonably familiar with economics can quite happily discuss inflation, unemployment, GDP growth and are aware of the effect of monetary policy (through rate changes) and fiscal policy (through taxing and spending). But even people very comfortable with economics are often unaware of what a ten year UK government bond (a gilt) is currently yielding.
I find this lack of interest baffling. Only by knowing the cost of government borrowing can what assess how much room for maneuver there is on fiscal policy. If one is unaware of the gilt yield then other widely cited statistics become meaningless: which country is more likely to have funding problems – one with a debt to GDP ratio of 40% or one with 100%? Depends entirely on the gilt yield if in the first case the yield is 12% and in the second only 4%, then the interest cost in case one is 4.8% of GDP whilst it is only 4% in the second.
To my relief, awareness of gilt yields is slowly seeping into the political world. To my horror, a lot of rubbish is being talked.
Let’s start with a chart. Showing the gilt yield over the past twenty years. It gives a bit of context.
Between 1989 and 1998 yields fell and then were range bound from 1998 until last year. After a sharp fall in 2008, they have ticked up again in recent weeks.
But looking at that chart it doesn’t look like the ‘markets’ are saying Britain is going broke! They are still prepared to lend to the government on ten year terms for less than 4%.
Charlie had an excellent post up a little while back outlining the ‘nightmare’ scenario which is the international markets calling time on the whole thing and refusing to lend to the Government. We are a long way from that.
Given the Tories have been banging the drum about how unsustainable the UK’s fiscal position is, the failure of gilt yields to soar must have caused much scratching of heads at Conservative Central Office.
The ever inventive George Osborne has come up with a new line to explain this.
George Osborne, who welcomed his party’s “massive lead” over Labour in the dual elections, will assert today that the assumption the Conservatives will take power within a year is a prime factor in reassuring international investors, concerned by the current political chaos.
The shadow chancellor will state that the usual assumption that re-electing the incumbent party is the safest option has been “turned on its head by the markets – re-electing Labour is now the risky choice”.
Mr Osborne will tell an Association of British Insurers conference today that his party’s “reputation for fiscal responsibility is already helping the recovery by shaping market expectations for the cost of government borrowing and debt in 12 months’ time”.
So, if gilt yields go up that’s because Britain is about to go broke and if they stay the same or go down, that’s thanks to the Tories. Curious.
What is being totally excluded from the political debate on gilt yields is the simple fact that the level of gilt yields is not solely determined by the prospect of default and the state of the public finances.
Of course these factors matter. But the UK is not going to default on its debt. No one realistically thinks it will.
There are a vast number of factors that determine yields – the expected rate of inflation, the likely course of short term interest rates, the perceived strength of the economy, the attractiveness of other assets – not to mention technical reasons such as pension funds matching their liabilities to long term, stable assets.
So here’s another chart. Gilt yields since the start of the credit crisis in August 2007, along with US, German and Swedish 10 year bond yields.
The obvious take away here is that all four are moving together. So are Canadian government bonds, French ones, Japanese ones… indeed pretty much most of the industrialised world’s bonds.
The point I am slowly labouring towards is this: the moves in UK gilt yields over the past weeks, months and even years tell us almost nothing about the prospect of default and the markets’ views on the Government. The Tories can scaremonger and moan all they like, but they are at best wrong and at worst dishonest.
If UK gilt yields head northwards whilst other yields stay the same or fall, then the markets will be telling us something. But at the moment, that isn’t happening.