WEBVTT - Here’s Why a Bond Market Doom Loop Is Brewing 0:00:02.520 --> 0:00:10.160 Bloomberg Audio Studios, Podcasts, radio News. I'm Caroline Hepger, and 0:00:10.200 --> 0:00:13.400 this is Here's Why, where we take one big story 0:00:13.640 --> 0:00:15.960 and explain it in just a few minutes with our 0:00:16.000 --> 0:00:21.880 experts here at Bloomberg. You've had this global bond slump 0:00:22.200 --> 0:00:24.599 that really picked up peace at the end of last week. 0:00:24.720 --> 0:00:26.759 People along bind they tend to look at these things 0:00:26.760 --> 0:00:30.440 and both inflation and demands for capital can push up brads. 0:00:30.560 --> 0:00:32.360 It starts to look a lot more interesting with thirty 0:00:32.520 --> 0:00:35.080 real yields levels that we haven't seen since the. 0:00:35.080 --> 0:00:38.800 GFC yields already high, curves are relatively steep, and central 0:00:38.800 --> 0:00:41.560 banks are probably going to be relatively slow to address 0:00:41.560 --> 0:00:45.440 the inflation problem. That's a perfect storm. Bonvigilenties love it. 0:00:46.120 --> 0:00:50.760 Bod markets are sending a warning. Long term boring costs 0:00:50.800 --> 0:00:55.160 have climbed across major economies. The pressure has been fueled 0:00:55.240 --> 0:00:59.640 by inflation fears linked to the Iran War. At the 0:00:59.680 --> 0:01:03.880 same time time, countries are adding to rather than cutting 0:01:04.040 --> 0:01:09.679 their debt. It's a combination that is rattling confidence because 0:01:09.680 --> 0:01:14.360 as borrowing costs rise, governments may need to borrow even more, 0:01:14.920 --> 0:01:18.000 and a vicious cycle could now be on the horizon. 0:01:18.840 --> 0:01:23.160 So here's why a bond market doom loop is brewing. 0:01:24.920 --> 0:01:28.680 Stephanie Flanders is Blueberg's head of Economics and Government and 0:01:28.760 --> 0:01:32.319 host of the Trumpanomics podcast, and she joins me, Now, 0:01:32.640 --> 0:01:36.120 what are bond markets trying to tell governments and central 0:01:36.160 --> 0:01:37.080 banks right now? 0:01:37.440 --> 0:01:39.240 I think there's a mixture of things. I mean, we're 0:01:39.280 --> 0:01:43.920 seeing the implied cost of borrowing if you're a government 0:01:44.040 --> 0:01:47.319 go up quite significantly. That's when you see the value 0:01:47.520 --> 0:01:50.600 of the government debt the bomb rice goes down and 0:01:50.680 --> 0:01:52.920 what they have to offer in terms of their interest 0:01:53.080 --> 0:01:55.520 rate goes up. That's how bond markets work, and there 0:01:55.520 --> 0:01:57.840 has been quite a steep increase, and I think that's 0:01:57.880 --> 0:02:02.320 associated with in the short term, realizing that this crisis 0:02:02.360 --> 0:02:05.200 in Iran and the closure of the straight orfor moves 0:02:05.280 --> 0:02:07.440 is going to have a significant effect on inflation for 0:02:07.520 --> 0:02:10.120 longer than people thought. It's also going to mean that 0:02:10.160 --> 0:02:13.480 central banks maybe have to respond to higher inflation. There's 0:02:13.480 --> 0:02:15.600 that short term thing going on, but I think also 0:02:15.720 --> 0:02:19.320 longer term investors are just looking at these governments that 0:02:19.360 --> 0:02:21.240 are sitting on a lot of debt, are sitting on 0:02:21.440 --> 0:02:24.840 rising costs of servicing that debt, and a lot of 0:02:25.080 --> 0:02:28.000 voters and populations who don't seem very keen on doing 0:02:28.000 --> 0:02:30.760 anything to bring that debt down. So I think there's 0:02:30.800 --> 0:02:35.160 also just bigger question marks about government's fiscal sustainability, if 0:02:35.160 --> 0:02:35.440 you like. 0:02:35.639 --> 0:02:39.760 Investors are increasingly worried about a government debt and in 0:02:39.800 --> 0:02:43.440 a lot of different developed economies. But I suppose I 0:02:43.520 --> 0:02:47.799 wonder why they are becoming so much more concerned about 0:02:47.800 --> 0:02:50.520 what has actually been a long running issue with government debt. 0:02:50.800 --> 0:02:53.280 Why the concern particularly now. 0:02:53.960 --> 0:02:57.240 Something very unusual happened after the Global financial crisis, that 0:02:57.320 --> 0:03:01.280 you had a big increase in debt as countries responded 0:03:01.320 --> 0:03:04.040 to the slowed down and the recession in the economies 0:03:04.080 --> 0:03:07.840 at that time, actually doubling of government debt in most 0:03:07.880 --> 0:03:11.280 of the advanced economies, But the cost of servicing that debt, 0:03:11.280 --> 0:03:13.680 because interest rates were falling lower and lower as central 0:03:13.680 --> 0:03:16.120 banks were trying to stimulate their economies, the cost of 0:03:16.160 --> 0:03:20.120 servicing that debt actually fell overall. So that was kind 0:03:20.120 --> 0:03:22.360 of a free lunch for governments. That's gone completely in 0:03:22.400 --> 0:03:26.079 the reverse. In the years since COVID, interest rates have 0:03:26.200 --> 0:03:29.680 been creeping up and the cost of servicing that debt 0:03:29.720 --> 0:03:32.600 for governments have been creeping up. So suddenly, in the UK, 0:03:32.720 --> 0:03:36.040 for example, instead of paying around fifty billion pounds a 0:03:36.120 --> 0:03:39.080 year interest costs on the debt, you're paying closer to 0:03:39.120 --> 0:03:42.200 one hundred billion, maybe higher, which starts to be, you know, 0:03:42.240 --> 0:03:45.040 more than defense, more than many other important bits of 0:03:45.080 --> 0:03:47.680 the economy. And then investors say, well, hang on a minute, 0:03:47.920 --> 0:03:50.600 how are they going to keep paying that bill when 0:03:50.680 --> 0:03:54.080 those bills for education, defense and health are also rising. 0:03:54.480 --> 0:03:58.040 Central banks, also, as you sort of mentioned, spent years 0:03:58.320 --> 0:04:01.680 helping to keep those borrowing costs low. So I suppose 0:04:01.880 --> 0:04:04.880 are we now about to see a new era of 0:04:05.480 --> 0:04:08.480 rising interest rates? You say they've been creeping up. Is 0:04:08.520 --> 0:04:11.480 this a sort of new moment for central banks? 0:04:11.880 --> 0:04:14.880 Yeah, in a way, we're going back to a normal time. Remember, Carolin, 0:04:14.920 --> 0:04:16.760 we had a lot of time where people were worried 0:04:16.839 --> 0:04:19.000 that central banks are sort of run out of ammunition 0:04:19.080 --> 0:04:21.760 because interest rates were at rock bottom and they had 0:04:21.800 --> 0:04:24.080 nowhere to go. Well, I guess the good news about 0:04:24.080 --> 0:04:27.080 the current situation is that with higher interest rates, they've 0:04:27.080 --> 0:04:29.200 got a lot more room for maneuver. We're both on 0:04:29.240 --> 0:04:31.800 the upside and on the downside. But of course the 0:04:32.200 --> 0:04:34.400 bad news is that means we're in a sort of 0:04:34.400 --> 0:04:39.560 slightly higher inflation, higher interest rate environment, and that I 0:04:39.560 --> 0:04:42.160 think we certainly the research that we've done about the 0:04:42.200 --> 0:04:45.680 sort of long term drivers of the cost of money 0:04:45.720 --> 0:04:48.560 of that long term interest rate, we think it is 0:04:48.680 --> 0:04:51.120 going up for a whole bunch of reasons, but in 0:04:51.200 --> 0:04:54.200 part because this is just becoming a more expensive world 0:04:54.279 --> 0:04:56.960 with all these shocks that we're seeing coming down the 0:04:57.000 --> 0:05:01.160 track and rising commodity prices and and things like that. 0:05:01.560 --> 0:05:05.120 So then we've used this term doom loop. Can you 0:05:05.200 --> 0:05:08.679 explain how a doom loop between debt and borrowing costs 0:05:08.720 --> 0:05:11.680 would actually work? I mean, one of the concerns has 0:05:11.720 --> 0:05:14.760 been also about a kind of disorderly bond market. 0:05:15.080 --> 0:05:19.640 The more that investors worry about government's ability to repay 0:05:19.680 --> 0:05:22.400 that debt, the more they demand a higher interest rate, 0:05:22.480 --> 0:05:25.240 maybe a higher risk premium on that debt. Then the 0:05:25.279 --> 0:05:27.159 bill goes up further, so they look at it again 0:05:27.200 --> 0:05:28.960 and say, wow, that really is going to be hard 0:05:28.960 --> 0:05:31.240 to cover. So you can see how that is a 0:05:31.279 --> 0:05:35.640 sort of negative spiral that is quite hard to break 0:05:35.800 --> 0:05:40.440 if governments haven't persuaded investors that they really do have 0:05:40.520 --> 0:05:43.160 a handle on that long term path or debt and 0:05:43.200 --> 0:05:45.240 I think that's why a lot of people, certainly a 0:05:45.279 --> 0:05:49.040 lot of investors and the sort of ratings agencies they 0:05:49.120 --> 0:05:51.320 look at whether a government has it doesn't matter. It 0:05:51.320 --> 0:05:54.279 doesn't matter so much if the borrowing is going up now, 0:05:54.440 --> 0:05:56.960 debt's going up now, But do they have a credible 0:05:57.040 --> 0:05:59.680 plan for putting it on a stable path and potentially 0:05:59.720 --> 0:06:03.880 even having debt fall relative to the size of the economy. 0:06:03.920 --> 0:06:06.280 And I think in quite a few countries, certainly in 0:06:06.320 --> 0:06:09.120 the US and potentially in the UK, that's just not 0:06:09.200 --> 0:06:09.920 the case now. 0:06:10.440 --> 0:06:13.480 If we are in this kind of new normal or maybe, 0:06:13.520 --> 0:06:16.080 as you say, you know, back to a more normal 0:06:16.160 --> 0:06:18.880 situation in terms of the cost of borrowing, what does 0:06:18.920 --> 0:06:19.360 that mean. 0:06:20.120 --> 0:06:22.720 There's many things to like about a world in which 0:06:22.760 --> 0:06:25.080 interest rates are a bit higher. Remember when we had 0:06:25.240 --> 0:06:27.440 very low interest rates, there was a lot of concerns 0:06:27.520 --> 0:06:30.880 about pensioners and others living off their savings couldn't get 0:06:30.960 --> 0:06:33.479 high interest rates. You know, some people like high interest rates. 0:06:33.839 --> 0:06:35.919 They want to be able to earn a high return 0:06:36.080 --> 0:06:39.479 from a safe asset like a government bond. That's a 0:06:39.480 --> 0:06:42.680 world that's happier for them. You also, in a sense 0:06:42.800 --> 0:06:46.560 have higher opportunity cost to money so maybe people take 0:06:46.600 --> 0:06:49.919 more care investors take more care about where they're putting 0:06:49.920 --> 0:06:53.080 their money because there's no easy returns to be had. 0:06:53.120 --> 0:06:54.960 You have to really think about, Okay, if I need 0:06:55.000 --> 0:06:57.279 to make a five percent to six percent return on this, 0:06:57.400 --> 0:06:59.640 am I investing it in the right place. I think 0:06:59.680 --> 0:07:02.480 that's quite healthy. And as I said before, there's also 0:07:02.520 --> 0:07:05.360 the kind of central banks having more room for maneuver, 0:07:05.440 --> 0:07:07.440 not being stuck at the bottom where we were when 0:07:07.480 --> 0:07:10.200 interest rates were sort of nine percent one percent. That's 0:07:10.360 --> 0:07:13.080 fine once you get there potentially, and everyone's got used 0:07:13.120 --> 0:07:16.120 to that different world. I think the challenge always is 0:07:16.160 --> 0:07:19.520 how do you make that adjustment and what gets broken 0:07:19.600 --> 0:07:21.559 on the way there. So there'll be lots of people 0:07:21.600 --> 0:07:24.400 currently and we see this in mortgage markets over the 0:07:24.480 --> 0:07:26.800 last few years. People have borrowed at very low rates 0:07:26.800 --> 0:07:28.720 and then they get real sticker shock when they go 0:07:28.840 --> 0:07:31.760 to refinance their mortgages, particularly in places like the UK 0:07:31.840 --> 0:07:34.560 where people are doing that on a regular basis. So 0:07:34.800 --> 0:07:36.960 I think what we worry about most of the economists 0:07:37.000 --> 0:07:39.520 is not necessarily that sort of steady state where we've 0:07:39.520 --> 0:07:43.040 gone back to normal, if you like, kind of historically 0:07:43.080 --> 0:07:46.240 normal interest rates. But what's going to happen on the 0:07:46.320 --> 0:07:49.160 way there and who's going to get burnt in the process. 0:07:49.600 --> 0:07:52.560 Always about the speed of change, isn't it bo's head 0:07:52.560 --> 0:07:56.000 of Economics and Governments, definitely Flanders. Thank you. For more 0:07:56.040 --> 0:07:59.520 explanations like this from our team of three thousand journalists 0:07:59.560 --> 0:08:02.120 and analysts around the world, go to Bloomberg dot com 0:08:02.160 --> 0:08:07.920 slash explainers. I'm Callain Hepka. This is here's why. We'll 0:08:07.960 --> 0:08:10.680 be back with more next week. Thanks for listening.