Bond holders want an ever-higher premium to hold the debt of developed-nation governments as turmoil in France and Japan underscores how politics is eclipsing central bank policy globally as a key market driver.
A gauge of French bond-market risk rose to its highest levels this year last week after Prime Minister Sebastien Lecornu resigned amid a budget impasse, only to be reappointed Friday night. In Japan, longer-maturity bonds plummeted as Sanae Takaichi’s surprise elevation to the top of the ruling party spurred concern about greater spending. Days later, her governing coalition had collapsed.
It’s a familiar predicament facing governments globally: Investors demand fiscal consolidation, while anything resembling austerity can prove politically contentious and toxic at the ballot box.
Geopolitical tensions are compounding the pressure. U.S. President Donald Trump threatened a “massive increase” of levies on Chinese goods on Friday, the latest move in a trade war that’s dimming the outlook for economic growth.
“Geopolitical risk and political risk has increased,” said Chris Iggo, chair of the AXA Investment Management Institute and chief investment officer of AXA IM Core. “And it’s only getting worse. Over the next decade, I think political risk will remain high.”
On the flipside, even as politics encroaches on markets more than ever in the U.S. — and a government shutdown deprives investors of key data — Treasuries have nonetheless retained their haven appeal through bouts of volatility. The dollar just came off its best week in almost a year.
Elsewhere, real yields — the rate on bonds after adjusting for inflation — are reaching new highs. For Commerzbank AG’s Christoph Rieger, head of rates and credit research, this reflects “rising political risks” as well as the need for governments to sell ever more debt, he said.
Long-end real yields are now noticeably above potential growth rates in many countries with top credit ratings, from Germany and Italy to France and the U.K., he warned.
“Investors need to be wary of an adverse, self-reinforcing dynamic that could endanger debt sustainability,” Rieger said. “The pain will probably intensify before painful adjustments can be made and a new, sustainable equilibrium can be found.”
In the U.K., the government’s borrowing costs are the highest among major developed markets. Bond investors are bracing for the end of November, when the Labour Party will present its budget to parliament. Officials are scrambling for ways to plug a £35 billion ($46.6 billion) shortfall without breaking the politically sensitive pledges made on tax rates at the last election.
Low Competence
In France and the U.K., investors are taking the view “that there isn’t a lot of competence in government to really make the structural reforms, spending cuts and tax increases necessary,” AXA’s Iggo said. “Politics is so fragmented.”
For investors like Lauren van Biljon, a senior portfolio manager at Allspring Global Investments, it’s a backdrop that points to ongoing steepening in yield curves around the world.
Even in Japan — where curves are already significantly steeper than in the likes of the U.K., U.S. and France — she sees further room for the move to play out. The abrupt collapse of Japan’s governing coalition has plunged the country into one of its biggest political crises in decades.
Ongoing uncertainty “keeps me wary of having too much duration in Japan, even given current yields on long-dated bonds,” van Biljon said.
In the U.S., by contrast, investors appear broadly comfortable with the elevated uncertainty — because yields offer sufficient compensation.
After buying long-dated Treasuries at higher yields in recent months, George Catrambone, head of fixed income at DWS Americas, recently turned neutral across the curve.
“There’s no sign of aversion for U.S. Treasury debt,” he said. “The U.S. still retains some exceptionalism and where else are you going to invest when you see the fiscal issues in Japan, France and the U.K.”
Even in the U.K., some investors are cautiously optimistic.
Gilt yields at their highest levels in decades suggest the U.K.’s fiscal challenges may be priced in, according to Citigroup strategist Jamie Searle.
If Chancellor Rachel Reeves does surprise and deliver tax increases and spending cuts, it would spur gilts, Searle said, recommending that clients position for U.K. bonds to outperform their French peers.
“On the other side, the risk is that any gilt-positive measures come with significant political cost,” he added.
In France, meanwhile, bonds retraced much of their recent selloff by the end of the week, as concern about the possibility of a fresh election abated.
Still, the compromises that may be required to placate the rival parties and get a budget through parliament — such as suspending hard-won pension reforms — risk leaving France in a worse position fiscally, and vulnerable to further bond market swings.
“The big question is when markets decide that enough is enough and force a change in both public and political attitudes,” said Felipe Villarroel, partner and portfolio manager at TwentyFour Asset Management.