This is the chart for movements in the interest rate implicit from the price of UK 10-year government bonds yesterday:
This is the equivalent chart for US 10-year Treasury bonds at the close of trade there:
The upward trend in those charts seen early in the data yesterday should most definitely not have been happening.
If stock markets are in meltdown, and they were most of yesterday, investors should have been looking for safe assets in which to hold their funds. Traditionally, this role has been played by government bonds. In that case, if shares were being sold, then there should have been increased demand to buy bonds, both in the UK and USA.
It is important to remember that the interest rate and government bonds move inversely. That is because once a bond is in issue, the interest paid on it never changes. So, for example, if the rate at the time of issue was 10% (picked for the sake of convenience) and the current market interest rate on bonds is 5%, the market value of the bond in question is broadly speaking, double the issue price, although this equation is, of course, impacted by the time left until redemption takes place. As a result, the fixed interest payment reflects the current market rate on bonds.
Bearing this in mind, if the interest rate on both UK and US 10-year bonds went up yesterday, that must mean the price of these bonds fell. In other words, instead of investors buying bonds as anyone would reasonably expect, given what was happening on the stock exchanges for much of the day, where indices fell, bonds were, in fact, being sold, which is the mechanism that will result in the price falling and effective rates rising.
Logically, those falls in prices should not have taken place. So, why did this happen?
I am to be candid, unable to give a definitive answer to that question, because I doubt that anyone can. In such a confused market, irrational things can happen. I stress, that might be a sufficient explanation for this phenomenon. It is important to bear this in mind when noting the other suggestions I make below.
Alternatively, if there is to be some rationality to this, then that might be found in the US bond market. If Trump is, as I noted yesterday, planning to tell the international owners of US treasury bonds to surrender their existing holdings in exchange for others of longer duration and lower nominal interest rates, in effect triggering a default on US bond obligations, which possibility seems to be quite real at present, then it is entirely rational for US bond market to increase their interest rate demand to reflect the increased risk inherent in US treasury bond holding. This might be sufficient explanation for what is happening in the US market.
That does not, however, explain why the same phenomenon was being seen in UK bond markets. After all, whatever Trump might wish to do, the likelihood that he will interfere directly in the UK bond market is low. So, is this movement simply a reflection of the dominance of the US markets, which the UK market is mimicking, quite illogically given the quite different risk profiles within the two?
Or is the commonality in the moves because both countries are believed to face substantial risks of increased inflation, and as a result, there is a real chance that both central banks are going to increase rates, even though Trump is demanding otherwise of the Federal Reserve?
Or is it that UK bond markets realise that Starmer and Reeves are headless chickens at this point in time, without a clue how to react to world events going on around them, and therefore believe that the risk premium on UK gilts or bonds needs to rise for that reason?
As I have noted, I have no certain answers to these questions because I do not believe that anyone knows precisely.
What I do know is that last night's change of heart on tariffs from Trump only confuses matters further.
What does, however, worry me is the sheer lack of logic in all this. When nothing appears rational, anything can happen, and that is the world that we are now living in.
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Yesterday I asked ChatGPT a question related to this. Here’s the exchange:
As a result of the introduction of high tariffs by President Trump over the last few days, there are new problems in the US Bond market. The value of Bonds has fallen and the interest payable on them has risen significantly. In the UK, there is talk of a series of interest rate cuts by the Bank of England over coming months, to support the economy. What will be the impact of the US interest rate increases on this plan?
ChatGPT said:
Rising US interest rates can have several knock-on effects that might complicate the Bank of England’s plans for rate cuts:
Capital Flows and Exchange Rates:
Higher US yields typically attract global capital. If investors shift funds from the UK to the US in search of better returns, this could put downward pressure on the British pound. A depreciating pound can, in turn, drive up import prices and contribute to inflation in the UK—making it harder for the Bank of England to justify cutting rates.
Global Tightening of Financial Conditions:
US interest rate hikes contribute to a tightening of global monetary conditions. Even if the UK economy is weak, if global rates rise, this can limit the effectiveness of domestic easing. The Bank of England might face pressure to maintain or even raise rates to keep up with global trends, rather than cutting them.
Inflation Concerns:
While the UK might be looking to cut rates to stimulate its economy, higher US rates could indirectly fuel inflationary pressures in the UK if the exchange rate depreciates or if imported costs rise. This creates a challenging scenario: rate cuts are generally intended to boost spending, but if they lead to higher inflation due to external pressures, the benefits might be offset.
In Summary
If the US raises its interest rates—which could be a response to high tariffs and bond market pressures—it may complicate the Bank of England’s plans to lower rates. The risk of capital outflows, currency depreciation, and imported inflation might force the Bank of England to delay or reconsider rate cuts, or to implement them more cautiously. In a globalized financial system, the monetary policy decisions of major economies like the US often have a significant impact on others, and in this scenario, the higher US rates could effectively counterbalance the UK’s domestic stimulus efforts.
“What I do know is that last night’s change of heart on tariffs from Trump only confuses matters further.
What does, however, worry me is the sheer lack of logic in all this. When nothing appears rational, anything can happen, and that is the world that we are now living in.”
You have a deliberately crashed stock market, you tell your family and friends to buy various stocks, you announce a pause in the introduction of tariffs and BINGO!
This may be a bit far-fetched though.
Are you sure?
No one can be sure.
But when the president makes a series of important announcements while the markets are open, which it can be foreseen would move the market down or up, and there is almost certainly a circle of dozens or more people who already know the content of the announcements, there is at least the opportunity for the insiders (or their friends or family who are tipped a wink) to make a killing by buying and selling before and after the market moves (or vice versa). And the US government has been making deep cuts at the regulators.
Cui bono?
Of course it could just be chaotic. But chaos also presents an opportunity for someone to profit, if they have a little advance warning.
Your scepticism is justified, in my opinion.
Agree: a form of market manipulation. Tell friends (tweet) to buy buy buy , and go get rich. Then hours later, tariffs pause and US stock market rises sharply
The idea that there is a ‘wisdom of crowds’ is just a way of describing a form of mass public opinion or reaction to something.
But what is often ignored are the inputs that inform those behaviours. There is a form of wisdom operating when people sense something is wrong in other spheres of life – for example the disapproval of Musk’s behaviour and a drop in sales of the Tesla cars and other ‘Ratner moments’ when the publics perceptions are altered and they become for or against something.
But from what I can see in finance, 2008 taught us that the ratings agencies and the market itself cannot really value anything properly at all, it seems to have little substance. The inputs are questionable. And there is a herding type quality to it all too – simply copying trends in the hope of making money as quickly as possible and cashing you chips in. And this is all done in complete ignorance or even lack of concern that such short term behaviour simply adds to the choppiness.
The main concern is that this irrationality is allowed to dominate everyday life. Markets are in reality just play things for the very rich to play in and make money. That is the only reason markets like this are tolerated – like much else that we have to bear on behalf of the rich.
Much to agree with
[…] they not noticed that the bond markets were sending out the message that the US government was not to be […]
Thanks for another interesting post.
I’m glad it is not just me who is wondering doesn’t understand.
Another possibility, no more likely to be right than any other, is that people are so nervous they are moving to cash (for which the interest rates are quite high).
Who knows.
I think they are moving to cash. You are right. It has to be true.
Many argue that the actions were rational, deliberate, and planned. As early as Monday night, Wall Street traders were openly discussing concerns that certain wealthy individuals may have been manipulating the market. Now, lawmakers—including Democrats and some Republicans—are using the term ‘insider trading.’ If it resembles insider trading, has the hallmarks of insider trading, then it’s reasonable to question whether that’s exactly what occurred.
The graphs show yields but what about the volumes being traded?
Clearly if people are not buying – or buying a lot that might say something about whats up
Accepted
And the answer is that market volumes appear to be high.
“Starmer and Reeves are headless chickens at this point in time, without a clue how to react to world events going on around them, and therefore believe that the risk premium on UK gilts or bonds needs to rise for that reason?”
Honest question: this statement may well be true(ish) but are they any different from leaders in the rest of the world? My guess is that even the heavyweights like the EU and China are flying by the seat of their pants, never mind what must be driving the leaders of the rest of the world. There are no precedents for the current mayhem.
As for the UK mirroring the US bonds, the UK has left the pack and we are vulnerable like a lone wolf. More risk, less mutual support.
I think your last paragraph answers your second paragraph
In the US various well-informed sources, including Bloomberg suggested the fall in bond prices was a function of hedge funds moving to close their positions in ‘basis trades’ because of the tariff decisions. Markets work well only in good times. In adversity the money runs away as fast as it can, and leaves everybody else to pick up the pieces. Money has no sense of responsibility, except to itself; not even responsibility to the markets money uses. The more complex the market environment, the more powerful and free from regulation or oversight the prime players in it (banks, pensions, insurance and hedge funds – they will exploit markets and their weaknesses for advantage, but desert them at the drop of a hat); and the more dangerous it becomes.
Markets cannot handle real adversity. Markets are not self-regulating mechanisms, save within essentially trivial oscillations, or immaterial spreads in volatility. Their stability is remarkably weak.
Agreed
In a changing irrational world where anything can happen (subject to the algorithms), or possibly already has, we all need some solid rock to stand on.
I can’t find solid “rock” exactly (unless we get religious) but at least, thanks to Rachel & Keir, we have “cast iron fiscal rules” to steady us all, here in Little Britain.
I can’t quite work out the link between “agile” ceremonies and “cast iron” fiscal rules but I’m sure Morgan McSweeney will explain it soon to the PM, and Pat McFadden will enforce it in the PLP.
Gillian Tett in the FT suggests looking to hedge funds for a possible explanation for bond market volatility because they are being forced to unwind their so-called “basis trades”.
She says: “This is a once-arcane strategy which involves making “leveraged bets, sometimes up to 100 times, with the goal of profiting from the convergence between the futures price and the bond price”, as Torsten Slok of Apollo private capital group puts it.
In recent years, such trades have exploded — albeit on a scale that is hard to track. Indeed, the explosion is so marked that three of the top five sources for non-US Treasury demand have been Luxembourg, the Cayman Islands and London — hedge fund centres.”
Estimates suggest the trades are worth $1tn and hedge funds hold 7% of all Treasuries.
Tett also mentions default risk and other factors https://www.ft.com/content/d5986c38-6c60-4869-b28a-f1dfb0868c3e
It’s like 2008 when nobody knew quite what was happening and why, and much of the financial engineering responsible for the credit crunch was only just coming to light. Except this time it’s largely down to one man’s madness and hubris. It’s Liz Truss writ large!
But in a way it is not like 2008 – we were supposed to have learnt lessons.
We have not and here we go again.
As Government bond trader for (too many) years, I have lived/breathed the bond basis (sad, I know).
There are lots of UST bonds with very similar characteristics – just slightly different maturity dates and coupons. Frankly, as an investor, it does not matter much which you buy – they will all deliver the same sort of return. Because they are so similar their prices move very closely together… and if they don’t a market maker (as I was) but now more likely a Hedge Fund (as dealer risk capacity is much diminished) will buy the cheap one, sell the expensive one and wait for things no normalise. It comes in three flavours UST v UST, UST v UST Futures and UST versus swaps. So far so good…. except when the markets go wild. In a panic these relationships get very stretched and, given the leverage, the losses get big – big enough to force the HFs out of the trade. Getting out in volatile conditions exacerbates things and a crisis can ensue.
LTCM was doing this in 1998 and went bust…. and they were doing almost exactly the same thing then.
But, the point is that the trade is always long one and short another bond/swap/future; the unwind is “market neutral”. It is the market volatility that causes the stress in the basis trade -not the other way round.
If a minor bit of trouble in the bond basis were all it was then we can move on…. but I fear it is greater than that. Foreigners are getting out of USTs and the domestic bid is not big enough to take it without a serious rise in yields.
Thanks Clive
Actually, a good analysis of this just posted in FT Alphaville. It appears the Treasury basis is not the culprit, more like the swap spread.
The UST basis issue is easily solved – The Fed bids the bonds that HFs want to sell and sell those that they want to buy….. at prices that cause serious pain but not destruction.
The swap spread is harder. Over the life of the bond, buying USTs and paying fixed in swaps IS an arbitrage assuming you can finance your long UST position at SOFR… which is (virtually) the definition of SOFR. Of course, some capital is required to run the trade but this widening (to a largish negative number) suggests someone has dumped USTs (outright, not on a spread) into the market and there is nobody that really wants them. This is not so easily solved. QE could work but seems the wrong approach at these rate levels. The bottom line is that foreigners are less willing to hold USTs and the price will have to adjust to a level where domestic buyers emerge in enough size.
Thanks
The problem, as you say Mr Parry is volatility; but volatility is a market risk, and it recurs, and recurs and recurs. Was the UK Pension business not caught out during the Truss hiatus Government with a Budget causing volatility in Pension funds who were dabbling in LDIs (sudden exponential risk – the clue is even in the name); another large scale finance sector collapse was only averted by a guiltily misfiring BoE having to use £30Bn of government money to rescue the pension industry. Why on earth were Pensions in LDIs? Pension funds should be excessively risk averse.
Volatility is a pernicious and permanent fact of the world we heve built, do not understand, but have no shoice, except to live in it, and by it. Equilibrium is a complete illusion; correction – delusion. And we are still caught out = every single -time it erupts. It is always a surprise. We never see the discreet over-commitment of the hedge funds, banks or pension funds that are caught out in some high risk activity they thought they could exploit cheaply forever; until it blows up in their face; and ours.
Some craven politicians and central bankers need to find a spine, and provide some oversight, regulation and severe penalties (and some people, somewhere who actually understand what they are doing). Or one day there will be no recovery to which we can resort.
Not to me. And it shouldn’t be for everone else. When the facts change…..
What we are incredibly short of are people capable of seeing big pictures.
Do you think they will release a moving film? “The Madness of King Donald”?
Rik
Gilts are trading poorly – more poorly than one might expect.
I would note that the charts you show are not quite synchronous as the USTs rallied after the gilts had close yesterday – they have, to some degree, caught up.
But that does not really explain things. If foreigners are selling USTs that should mean a reduced impact on non-US bonds (like gilts). I fear it is investors voting (with their feet) on the credibility of the BoE (who will be selling £600mm long dated gilts on Monday as part of QT (sorry – in a prior comment I said it was today but it is Monday)) and dragging their feet on Base rate cuts.
Oh, and don’t get me started on Reeves/Starmer….
QT right now is an act of economic vandalism
Quite
BoE just pulled this QT sale. Finally some sanity.
Thank goodness
As the gilt market closes we see it has done well today versus USTs (and outright). Some sense prevailing.
The UK policy makers might be bad…. but they are not barking.
I am trying hard not to comment just now; but living through this extraordinary watershed moment in the world makes that very difficult. Then, Mr Parry you make a telling point that makes everything seem worse ……………..High Interest Rates. QT. Oh, and Brexit.
As for the BoE. Could you name one financial crisis, say back to 1825; in which we can confidently say the BoE understood what the problem was, and knew what they were doing?
The perfect Three No Trump? Low Interest Rates. No QT. No Brexit. But that hand is beyond us.
Join the gloom club John.
Add to these gloomy facts, the seemingly careless way in which governments in the UK and US are trashing copyright laws in obeisance to Dark Enlightenment tech overlords. Will this move not eventually eradicate the very foundation stone of all capitalism, that of property ownership ?