Bond Crisis

Hi, welcome back to the channel. In today's episode, I want to talk about the ongoing damage being caused to the global economy by the war in Iran. Because this is no longer just showing up in the oil price. Yes, oil is still a major problem. Yes, fuel costs, shipping costs, freight costs, and energy costs are still feeding through into businesses, consumers, and inflation.

But now there is another problem developing. And in some ways, this one could be even more dangerous. And that is what is happening in the bond market. Because around the world, long-term government bond prices are falling, yields are rising, and that means the cost of borrowing is going up. And when governments already have huge levels of debt, rising yields can quickly become a very serious problem.

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Now, coming back to the issue of bonds, higher bond yields mean higher debt costs for governments. Higher debt costs mean less money for public services, defense, infrastructure, tax cuts, benefits, investment, and economic support. And if governments respond by borrowing even more, that can push yields even higher, creating a vicious circle.

So, let's start with what's just happened. One of the latest warning signs came from 3II, the private equity group, which owns a very large stake in Action, the discount retailer. Action is supposed to be exactly the sort of business that does well when consumers are under pressure. It sells cheap products. It's low cost. It's value focused. In a cost of living squeeze, people normally trade down into businesses like this. But three eyes warned that sales growth at action has slowed sharply and the market reaction was brutal. The share price has fallen heavily more than 20%.

Because investors looked at that and thought, "Hang on a minute. If even a discount retailer is being hit, what does that say about the state of the consumer?" And this is the key point. This isn't just a luxury spending problem. It isn't just people cutting back on expensive restaurants, holidays, or designer clothes. We are now seeing pressure in areas of the economy that are supposed to be defensive. And that matters because if inflation is squeezing people so hard that even low-cost retailers are starting to feel it, then the pressure is spreading deeper into the real economy.

And action is not the only example. Across Europe, retailers have been warning that higher fuel costs, higher freight costs, and higher supply chain costs are starting to feed through. Next, the retailer has warned about extra costs linked to fuel and freight. H&M has warned that a prolonged conflict could increase inflationary pressures on consumers. Co-op in the UK has talked about consumers remaining cautious and other businesses exposed to transport fuel, food, shipping and imported goods are also having to deal with the same problem.

So this is the first layer of the story. The war pushes up oil and fuel prices that pushes up shipping, logistics, production and distribution costs. Businesses then have a choice either to absorb those costs or which hits their profits or they pass costs on to consumers which pushes inflation higher. But if they pass them on too aggressively, consumers cut back. So either way, this hurts them. It either hurts profits or it hurts demand and it hits them at the same time. And that's why the three iron action story matters because it's a real world example of the pressure spreading from the energy market into the retail market.

But let's now move on to the second part of today's video because this is where things become much much bigger. The bond market. A bond is basically an IOU. When a government borrows money, it issues bonds. Investors buy those bonds and the government pays interest to them. But bond prices and bond yields move in opposite directions. So when demand for bonds fall, bond prices fall. And when bond prices fall, yields rise. That means the government has to pay a higher rate of interest to borrow money. And that's exactly what we're seeing right now. The US 30-year Treasury yield is now sitting above 5%. The UK 30-year guilt yield is around 5.7%. And in Japan, the 30-year yield has been close to hitting a record 4%. Which is extraordinary for a country that spent decades with ultra low in interest rates.

Now, those numbers might sound boring, but they're not boring. They are incredibly important because these are the rates that sit underneath the global financial system. They influence mortgage rates. They influence company borrowing costs. They influence pension funds. They influence valuations in the stock market. And they influence how much governments have to spend just servicing their existing debt.

And this is the problem. Moes made to governments are already heavily indebted. The United States has a huge debt pile. The UK also has a huge debt pile. Japan has one of the largest debt burdens in the developed world. Many European countries are also under debt pressure. And when yields rise, the cost of refinancing that debt rises. Governments don't refinance all their debt overnight. So the impact becomes gradual. But over time, as old cheap debt matures and is replaced with new expensive debt, the total interest bill climbs and that can become a trap because the government then has to spend more money on interest. That leaves less money for everything else.

So politicians face a horrible choice. They can cut spending, they can raise taxes, they can borrow more, or they can try to inflate the debt away. But every option has consequences. Cutting spending can hurt growth. Raising taxes can hurt consumers and businesses. Borrowing more can frighten bond investors even more. And allowing inflation to stay high can force central banks to keep interest rates higher for longer.

So this is where the vicious circle begins. Higher inflation pushes bond yields up. Higher yields push government interest costs up. Higher interest cost worsen the budget position. A worse budget position means government need to borrow more. More borrowing means more bonds need to be sold. But investors are already nervous. They demand even higher yields to buy those bonds and that pushes the whole cycle round again.

This is why the bond markets matter and it's why the situation is so dangerous because the war in Iran is creating an inflation shock at exactly the wrong time. Governments are already struggling with debt. They were already struggling with deficits. They were already struggling with aging populations, higher defense spending, health care costs, infrastructure demands, and slower growth. And now, just as many countries were hoping inflation would come down and interest rates would fall, the energy shock has pushed the problem in the other direction.

That is really the damaging part because a few months ago, markets were still hoping that central banks might be able to cut rates. The assumption was that inflation would gradually ease, growth would slow, and central banks could start supporting the economy. But if oil, fuel, shipping, and food costs are rising again, central banks have a real problem. They can't easily cut interest rates if inflation is too high. In fact, markets are now starting to ask whether the same move in some countries might actually be up rather than down.

And that's very bad news for governments, consumers, and businesses because it means the pressure doesn't ease. Mortgage rates stay higher, corporate borrowing costs stay higher, credit card and loan costs stay higher, government debt costs higher, and investment becomes harder to justify. That then feeds into the real economy. Companies delay expansion, consumers delay big purchases, governments delay projects, house builders struggle, retailers struggle, transport companies struggle, and then the economy slows down.

So this is no longer just about the price of oil. It's a debt story. It's a bond market story. It's a confidence story and it is a global growth story.

Now to be balanced, we should say that bond yields rising is not always a sign of disaster. Sometimes yields rise because growth is strong. Sometimes investors demand high yields because they think the economy is doing well and inflation is normalizing. And in Japan, part of the move is also connected to long-term normalization of interest rates after decades of ultra low yields. So, we shouldn't pretend that every single move in the bond market is solely because of the war in Iran. There are domestic factors, too. The US has its own debt and deficit issues. The UK has its own fiscal credibility issues. Japan has its own demographic and monetary policy issues. Europe has its own budget and energy challenges.

But the point is that the war has made all of these existing problems much worse. It's added an energy shock on top of a debt problem. It's added inflation pressure on top of weak growth. And it's added geopolitical uncertainty on top of an already fragile investor confidence level. That combination is what makes this so dangerous because when investors buy 30-year bonds, they're lending money for a very long time. They're asking themselves, "Do I want to lock my money away for 30 years at this rate?" And if they're worried about inflation, debt, politics, deficits, currency weakness, war, and central banks losing control, they demand a higher return. That higher return is the bond yield. And the higher that that yield goes, the more expensive the whole system becomes.

This is why the 30-year bond is so important. It tells us what investors think about the long-term credibility of government finances. And right now, the message is not very comforting. The US is paying 5% for 30-year money. The UK is paying closer to 6%. Japan, which used to be associated with ultra low yields, is seeing long-term rates hit record levels. That is a major shift. And the danger is that the markets can move from concern to panic very quickly. Most of the time bond markets move gradually. But when investors lose confidence, they can move violently. We saw that in the UK in 2022 when guilt yields surged and pension funds came under pressure. We've seen it in emerging markets many time. And while the US, UK, and Japan are not emerging markets, they are not immune from bond market pressure. No country is immune if investors start demanding more compensation for lending.

So what does this mean going forward? It means governments are going to have less room for maneuver. They'll find it harder to cut taxes. They'll find it harder to increase spending. They'll find it harder to fund large new programs and they will find it harder to respond to the next crisis because more and more money will simply go on servicing debt. And that's the depressing part. Interest payments do not build hospitals. They don't build roads. They don't improve schools. They don't fund new technology. They don't improve productivity. They are just the cost of past borrowing. So when interest payments rise, future growth can suffer. And if future growth suffers, the debt burden becomes harder to manage. Because the best way to deal with debt is to grow the economy faster than the debt. But if high yields, high inflation, and high energy costs all reduce growth, that becomes much more difficult.

That is the vicious circle. Higher debt costs reduce growth. Lower growth makes debt harder to manage. Harder to manage debt makes investors nervous. Nervous investors demand higher yields. Higher yields increases the debt cost again. And on we go with that circle.

So when we're looking at what's happening in the global economy, we need to look beyond the oil price. The oil price is the obvious headline, but the bond market may be the bigger story because oil affects cost today. Bonds affect the cost of money for years. And if governments around the world are forced to borrow at much higher rates for much longer, the economic impact could last well beyond the current phase of the war. That is why the latest moves in the USA, UK, and Japanese bonds are so important. They are a warning signal. They're telling us that investors are becoming more concerned about inflation, debt, deficits, and the long-term cost of government borrowing.

And when the bond market starts sending that signal, governments have to listen because in the end, the bond market is where economic reality shows up. Politicians can promise more spending, they can promise lower taxes, they can promise support packages, they can promise subsidies, but if investors don't want to fund it cheaply, the cost goes up and that cost eventually lands somewhere. It lands on taxpayers, it lands on consumers, it lands on businesses or it lands on future generations. So in my view, this is one of the most important developments in the global economy right now. The war in Iran is not just creating an energy shock. It's creating an inflation shock. It's creating a consumer squeeze. It's creating corporate pressure. And now it's feeding into the bond market where the cost of debt is rising across major economies. That is why this matters because once the cost of debt rises, it changes everything.

So, I'll keep you posted on any further news and developments on the bond market and other stories. But hopefully, you found today's video useful, informative, and most importantly, thought-provoking. If you've liked what I've said, or maybe you didn't like it, but you thought it's interesting, then please give me a thumbs up. Please subscribe to the channel if you haven't done so already. Drop me a comment below on your thoughts on the bond market. I'd be delighted to have a look at that.

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