Why the bond vigilantes have got it wrong again

It is difficult to say who is the most clueless when it comes to the outlook for Britain's public finances. Certainly, one can easily laugh at the Labour MP who told The Times that the bond markets “will have to fall into line” if Manchester mayor Andy Burnham becomes prime minister with a more left-leaning agenda.

Yet the way that bond yields have fluctuated according to the perceived odds that Keir Starmer, Britain's least charismatic, least visionary prime minister in living memory, will cling on in his doomed course for a few more months, suggests that the bond markets themselves are having equal trouble grasping reality.

I am always dismissive of “bond vigilantes” because the truth is that these self-proclaimed upholders of financial law and order have long shown a willingness to fall into line with whatever lunacy prevails.

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Where was the bond vigilante revolt when central banks cut interest rates to zero and long-term yields fell to derisory and even negative levels in the 2010s? Who thought that loading up on ten-year bonds in that climate – or 30-year bonds or instruments of pure financial self-harm such as Austria's 100-year bond with a 0.85% coupon – was wise?

Yet bond markets got comfortable with the insanity. If not, central banks would have been the only buyer.

Bond vigilantes are letting the real criminal get away

Of course, a defining trait of bond vigilantes is their tendency to do more harm than good by pointing the finger at the wrong culprit and lynching the innocent. So maybe the label is accurate in a way that isn't intended. After all, while many of the policies preferred by the left of the Labour Party are clearly economically harmful, one cannot with a straight face claim that what Keir Starmer and Rachel Reeves are pursuing will avert eventual disaster. Or – to be non-partisan – deny that the governments that preceded them are equally culpable for where the UK stands.

What Britain needs is a combination of pro-growth, pro-business policies combined with huge investment in the physical and social infrastructure needed to facilitate this and address the growing anger and despair that voters feel. Gilt investors seem averse to any hint of the latter. They appear not to fully appreciate that the consequences of the failing status quo will be much more populist governments that will ramp up spending far more recklessly.

One may argue that an Andy Burnham government implies that the ten-year bond yield should be above 5%. I would agree, not least because today's yields are only high if you view the central-banking malfeasance of the 2010s as normal (see chart below). Yet three more years of Starmer (or similar) merits an even higher yield due to the rising probability of even worse outcomes. Fixating solely on “fiscal restraint” is very short-term thinking – not wildly different from buying a century bond to pick up a smidgin of extra yield for a few years.

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