Latest / Global Insights / The Bond Market Strikes Back: New Limits on Sovereign Power?

Transcript

The Bond Market Strikes Back: New Limits on Sovereign Power? · Global Insights

• 0:00
  SPEAKER_00: When a country's fiscal dynamics have gotten to a point where if you don't have austerity, even though it'll slow growth, no one wants your assets anymore.
• 0:11
  SPEAKER_02: America owes more than any other government in the world.
• 0:16
  SPEAKER_02: It owes most of that money to investors, and investors can change their minds.
• 0:21
  SPEAKER_02: In 2022, they changed their minds about Britain.
• 0:24
  SPEAKER_02: That September, its new government under Liz Truss announced the biggest tax cuts in 50 years, paid for with borrowed money.
• 0:33
  SPEAKER_02: Investors rushed to sell British government bonds, and within days, banks were pulling mortgage offers.
• 0:39
  SPEAKER_04: The UK government had four days, four business days, during which it had to deal with a huge bond market turmoil, and it was unable to do that.
• 0:48
  SPEAKER_04: The government had to resign.
• 0:52
  SPEAKER_02: And America's debt is many times bigger than Britain's.
• 0:57
  SPEAKER_02: But the dollar is the world's main currency, and central banks and investors everywhere keep much of their savings in American government bonds.
• 1:06
  SPEAKER_02: For decades, that has meant someone is always willing to lend to America.
• 1:11
  SPEAKER_02: The question is whether that will last.
• 1:14
  SPEAKER_03: There are early signs that our room for maneuver is not unlimited, that the share of central bank holdings of foreign currencies, the share that is held in dollars, has been declining over time.
• 1:32
  SPEAKER_02: This is Global Insights by Network 2020.
• 1:36
  SPEAKER_02: Today, governments and the bond market.
• 1:47
  SPEAKER_02: Joining us today is Professor Darrell Duffy of Stanford, past president of the American Finance Association, who studies how bond markets hold up under stress.
• 1:55
  SPEAKER_02: Professor Barry Eichengreen of Berkeley, a former senior policy advisor at the International Monetary Fund, and a historian of the dollar.
• 2:04
  SPEAKER_02: And Rebecca Patterson, Senior Fellow at the Council on Foreign Relations, and former Chief Investment Strategist at Bridgewater Associates, the world's largest hedge fund.
• 2:13
  SPEAKER_02: Our conversation is moderated by Courtney Dockard, president of Network 2020.
• 2:21
  SPEAKER_01: So just to set the scene, as many of you know, governments borrow by selling bonds.
• 2:26
  SPEAKER_01: Investors decide what return they require to hold them.
• 2:29
  SPEAKER_01: And then we've had many years of exceptionally cheap borrowing.
• 2:33
  SPEAKER_01: But several governments, including the US, I believe Japan, the UK, France, facing higher financing costs that can make some political promises more expensive to keep.
• 2:44
  SPEAKER_01: And while central banks are able to influence short-term interest rates to manage inflation and the economy, they do not get to simply dictate what a government pays to borrow for 10 or 30 years.
• 2:55
  SPEAKER_01: And so investors are key here.
• 2:57
  SPEAKER_01: They weigh inflation, growth, the supply of debt, and confidence in policy.
• 3:02
  SPEAKER_01: So all of that affects room for defense, for infrastructure, and public services.
• 3:08
  SPEAKER_01: And because the US government borrowing helps set the price of money worldwide, the consequences reach beyond our shores.
• 3:16
  SPEAKER_01: And as many commentators, now that going back to the midterms, are pointing out that foreign policy is where lame duck presidents tend to focus, how the government finances those endeavors impact all of us.
• 3:28
  SPEAKER_01: So our central question today is how much room do governments still have to act?
• 3:32
  SPEAKER_01: And what happens when bond markets narrow that room?
• 3:35
  SPEAKER_01: And so we'll be looking at that broadly from a few different angles.
• 3:39
  SPEAKER_01: So, Rebecca, I'd love to begin with you on what the market is actually telling us.
• 3:45
  SPEAKER_01: So uh we're in an interesting day, um, but in general, kind of looking both today, but a little bit more broadly.
• 3:51
  SPEAKER_01: What does it mean that we had been seeing higher yields?
• 3:54
  SPEAKER_01: And when you've been looking at the market, does it reflect a stronger economy or something that is more concerning?
• 4:02
  SPEAKER_01: And what are you looking at to distinguish between the two?
• 4:06
  SPEAKER_00: Great.
• 4:07
  SPEAKER_00: Well, first of all, it's wonderful to be here with you.
• 4:10
  SPEAKER_00: And uh certainly wonderful to be with Barry and Daryl.
• 4:13
  SPEAKER_00: Um, I'm big fans of both.
• 4:15
  SPEAKER_00: This move in government bond yields, whether we're talking about the US Treasury market, France, Japan, UK, et cetera, none of this is particularly new for most developed country bond markets, yields have been rising now since their lows at the beginning of the pandemic in 2020.
• 4:33
  SPEAKER_00: I think what's a little different today is that what's driving the yields, the level of yields, the speed of the move in yields is different.
• 4:43
  SPEAKER_00: And so it's worth having this conversation about it, um, whether it's benign, reflecting just strong economic fundamentals, strong growth, expectations for that to continue or something else.
• 4:54
  SPEAKER_00: And I'd just make three very quick points about this.
• 4:57
  SPEAKER_00: First is that despite all the volatility and energy prices and the war in Iran, what we've seen, especially in 2026 with government bond yields, is not particularly about inflation.
• 5:09
  SPEAKER_00: If you look at market measures of inflation, what we call break-even inflation, it hasn't moved very much at all.
• 5:16
  SPEAKER_00: It's really been a move in what we call real yields.
• 5:19
  SPEAKER_00: So they've gone up from for about 100 basis points from their recent lows in February.
• 5:25
  SPEAKER_00: So that's a big move and fairly quick one.
• 5:28
  SPEAKER_00: And they've been driven by solid growth, uh, which in turn, especially in the US, has been driven in large part by artificial intelligence, AI, and then expectations that the growth and the inflation that's sticky above central bank targets would lead to central banks having a tightened monetary policy.
• 5:46
  SPEAKER_00: So that's the first main thing.
• 5:47
  SPEAKER_00: And growth driving yields is more benign because if it's growth led, that has implications for other countries that benefit from strong growth and demand in the US.
• 5:58
  SPEAKER_00: And if it's growth led, it usually means that companies are seeing good earnings, good revenue, and that means consumption and you have higher equity markets.
• 6:07
  SPEAKER_00: And indeed, that is what we've seen this year.
• 6:09
  SPEAKER_00: The second quick point I'd make on this, again, just setting the stage, where are we today, what's driving it?
• 6:14
  SPEAKER_00: There has been, and this is less benign, there has been a growing focus on fiscal situations and the difference between the amount of bond supply that we need to fund all these growing deficits and the amount of demand for those bonds and at what yield, what price to get those, to get that demand.
• 6:31
  SPEAKER_00: So the US budget deficit today is around just under 6% of GDP.
• 6:37
  SPEAKER_00: And you have large primary deficits in France and the UK and Italy.
• 6:42
  SPEAKER_00: All those deficits are pressuring borrowing costs.
• 6:46
  SPEAKER_00: AI debt issuance is an issue because there is so much debt coming for AI companies as they finance their growth.
• 6:54
  SPEAKER_00: It just creates an additional source of competition, if you will, for that demand for US government bonds.
• 7:01
  SPEAKER_00: So that would be the second point, that it is partially fiscal and that is more concerning.
• 7:06
  SPEAKER_00: And then the third thing I'd just highlight very quickly, and last thing I'd highlight, is that the level of yields does matter.
• 7:13
  SPEAKER_00: We're now at a point where 10-year government yields are at the highest levels we've seen in 10, sorry, 15 to 20 years or more, depending on the country we're talking about.
• 7:23
  SPEAKER_00: Again, I'm looking at developed markets here, but with more debt and higher interest rates, the interest payments governments have to make on the debt goes up.
• 7:32
  SPEAKER_00: And it's now expected to exceed defense spending this year in every G7 country except Germany and Canada.
• 7:38
  SPEAKER_00: And that just means these governments have less fiscal room for other priorities.
• 7:42
  SPEAKER_00: If they're spending money on interest payments, I think of that as like dead money.
• 7:47
  SPEAKER_00: It doesn't do anything to support growth.
• 7:48
  SPEAKER_00: It's just a legal obligation.
• 7:50
  SPEAKER_00: You have less revenue left over in your budget to spend on things like transportation, health care, military infrastructure.
• 7:58
  SPEAKER_00: So the money you want to spend to support growth, you have less of it because of those interest payments.
• 8:03
  SPEAKER_00: So to answer your question, some of the drop move in yields is positive.
• 8:08
  SPEAKER_00: It's benign, it's growth, but not all of it is.
• 8:11
  SPEAKER_00: So we have a bit of a mixed bag.
• 8:13
  SPEAKER_00: And it's something certainly given those levels, we have to watch carefully.
• 8:18
  SPEAKER_01: Thank you.
• 8:19
  SPEAKER_01: Um, Barry, Darrell, anything you want to add to that?
• 8:22
  SPEAKER_03: I would simply echo very quickly uh a number of things that uh Rebecca said, that inflation expectations remain well anchored, which is econom speak for everybody expects central banks to do whatever it takes to bring inflation back to target sooner or later.
• 8:43
  SPEAKER_03: And that the relative importance of data center investment on the one hand and uh government deficits on the other hand varies across countries, that it's probably uh heavily data center investment for the moment in the US, but heavily worries about fiscal sustainability in France.
• 9:04
  SPEAKER_03: And finally, there's the possibility, I think, of a risk premium sneaking in to further elevate rates, certainly in places like France, but even in the United States, where there is growing concern about policy uncertainty about whether either political party is serious about addressing the problem of chronic fiscal deficits.
• 9:30
  SPEAKER_04: Yeah, I I'd like to also react.
• 9:32
  SPEAKER_04: I the bond market is a global market.
• 9:35
  SPEAKER_04: So we can't go country by country and talk about imbalances in that country's bond market.
• 9:40
  SPEAKER_04: And uh, in order to understand where yields are going, we have to look globally and consistent with what Rebecca said.
• 9:48
  SPEAKER_04: All governments have been issuing a lot of bonds at supply is very important.
• 9:54
  SPEAKER_04: I'd also echo the point about AI and data center financing.
• 9:59
  SPEAKER_04: It's sometimes been said that these corporate issuers are crowding out government bonds.
• 10:05
  SPEAKER_04: But if you look at the numbers, it's really the other way around.
• 10:08
  SPEAKER_04: Governments are really the culprit here.
• 10:11
  SPEAKER_04: The US, for example, is issuing is running at like a$2 trillion deficit, all of which has to be financed in the treasury market, whereas the data centers are doing in the hundreds of billions a year, which is a lot, but um really the re reason that yields are up is that governments have been so actively issuing.
• 10:32
  SPEAKER_01: Great, thank you.
• 10:32
  SPEAKER_01: Um, Daryl, I'd love to just stay with you for a minute and just talk about what markets look like when they're really under stress, using a concrete example.
• 10:42
  SPEAKER_01: I think you've done some work on Britain and they had spiraling bond market turmoil in 2022 where there was this rapid rise in their government bond yields, which I, if I understand correctly, exposed many of the country's pension funds.
• 10:58
  SPEAKER_01: And then a selling space started this dangerous feedback loop.
• 11:02
  SPEAKER_01: Could you just use that example to help us understand what it reveals about how quickly financing conditions can constrain a government?
• 11:12
  SPEAKER_01: And also what it tells us, maybe more importantly, about the interventions to address these kinds of shocks.
• 11:18
  SPEAKER_01: And maybe not even just interventions, but maybe also preventative tools that governments can use.
• 11:25
  SPEAKER_04: Yeah, the the so-called uh mini-crisis, mini-budget crisis of uh a few years ago in the United Kingdom revealed that uh governments can't really run budget deficits to the extent that the bond market can react and force the government.
• 11:44
  SPEAKER_04: And that in that case, the Prime Minister Liz Truss had to resign within a few days of that budget because guilt yields jumped enormously, about 100 basis points in four trading days.
• 11:55
  SPEAKER_04: And this was uh mainly caused by intermediation problems in the guilt market.
• 12:02
  SPEAKER_04: Handling that fast uh an increase in yields over such a short period of time overwhelmed the intermediation capacity of that market.
• 12:10
  SPEAKER_04: But it was such a such a shock, and consistent with your your question, Courtney, it revealed that bond markets really have the upper hand over governments when they're that fiscally constrained.
• 12:21
  SPEAKER_04: I go back to the situation that President Clinton actually handled in 1993 when his political strategist James Carville famously remarked that if there was reincarnation, he said, I would like to come back at as the bond market, you can intimidate everybody.
• 12:43
  SPEAKER_04: And, you know, recent efforts by uh U.S.
• 12:46
  SPEAKER_04: Treasury Secretary Scott Bessant to control rises in U.S.
• 12:50
  SPEAKER_04: Treasury yields reveal really that Treasury Departments and finance ministries don't have the upper hand.
• 12:55
  SPEAKER_04: The bond market is far bigger and more powerful, and even the mighty U.S.
• 12:59
  SPEAKER_04: Treasury Department is not going to be able to and wasn't able recently to control yields uh when uh the global market suggests yields need to go up.
• 13:11
  SPEAKER_01: Thank you for that.
• 13:12
  SPEAKER_01: Barry, I'd like to pick up on a point that I think both Daryl and Rebecca have also mentioned, which is that we're in uh the bond market is global and US treasuries are really sitting at the center of global finance.
• 13:26
  SPEAKER_01: So if if this market comes under strain, how does that pressure travel across borders?
• 13:34
  SPEAKER_01: And what determines which countries are most exposed?
• 13:38
  SPEAKER_03: Um, as both Daryl and Rebecca have emphasized, the bond market is global and in investors are are looking for at relative yields and thinking about possible exchange rate changes when they decide where to invest.
• 13:55
  SPEAKER_03: So higher U.S.
• 13:56
  SPEAKER_03: yields will translate to an extent to higher yields abroad.
• 14:02
  SPEAKER_03: People who have looked at the global footprint of the dollar, I think uniformly conclude that changes in U.S.
• 14:11
  SPEAKER_03: yields have an outsized impact on foreign markets.
• 14:16
  SPEAKER_03: We affect them more than they uh affect us, if you will, because so many international transactions are are priced in dollars, denominated in dollars, the dollars used for cross-border payments.
• 14:32
  SPEAKER_03: So when it becomes more expensive to get your hands on dollars to source the currency that affects cross-border transactions disproportionately and in turn translates into, if you will, sympathetic market reactions, the same market reactions in the same direction abroad as at home.
• 14:55
  SPEAKER_03: The United States has more room for maneuver than the UK did in 2022 because there is this large elastic demand for dollar denominated debt out there in the rest of the world.
• 15:12
  SPEAKER_03: But I think there are early signs that our room for maneuver is not unlimited, That the share of central bank holdings of foreign currencies, the share that is held in dollars, has been declining over time.
• 15:28
  SPEAKER_03: The share of US public debt held abroad by official and private investors combined has been falling over time.
• 15:38
  SPEAKER_03: Uh, again, we benefit from the dollar's global role, but those benefits are not unlimited.
• 15:46
  SPEAKER_01: Thank you.
• 15:46
  SPEAKER_01: I think we did a good job kind of walking through some of the scene setting and what happens under stress and you know what what we might be looking at in terms of the elasticity of the ability for the US to maneuver.
• 16:01
  SPEAKER_01: And I'd like to kind of stay on that point with you, Rebecca, where governments are often they're trying to strengthen their own economic security through defense investments, secure supply chains, manufacturing.
• 16:14
  SPEAKER_01: Um, as an investor, how do they distinguish borrowing that strengthens a country's long-term position from the kind of borrowing that leaves it more vulnerable?
• 16:25
  SPEAKER_01: And you mentioned earlier for spending all our money on just interest payments, that's not a great use of funds.
• 16:30
  SPEAKER_01: But, you know, what's the investor perspective on this?
• 16:34
  SPEAKER_00: Yeah, it's been interesting.
• 16:36
  SPEAKER_00: When President Trump got elected for his second term, one of the factors that helped him become president again was his campaign pledge to bring uh manufacturing back to the United States, create jobs, create growth.
• 16:50
  SPEAKER_00: And you have seen this political support for candidates generally who are saying, we're gonna get you a better quality of life, we're gonna get you more jobs.
• 17:01
  SPEAKER_00: In Japan, you know, Prime Minister Takaichi is saying we're gonna do this fiscal stimulus to support growth, and we're gonna grow our way out of our debt effectively.
• 17:12
  SPEAKER_00: Uh, you're seeing similar in Germany, you know, the markets applauded when Germany weakened its so-called debt break, allowed itself more fiscal room to spend on things like infrastructure and defense because they thought, ah, finally, Germany can get faster growth that will create jobs and a positive flywheel effect.
• 17:29
  SPEAKER_00: I think the really important question today is how much growth do they get out of these efforts?
• 17:35
  SPEAKER_00: And I think the jury's still out because of the macro environment we're operating in.
• 17:40
  SPEAKER_00: And it gets back to a concept called a fiscal multiplier.
• 17:43
  SPEAKER_00: And I don't want to insult anyone's intelligence here, but just to make sure we're on the same page, we're really just talking about how much bang do you get for your buck?
• 17:52
  SPEAKER_00: What is the return on the government investment?
• 17:55
  SPEAKER_00: And right now, when you think about the factors that determine how much benefit, how much growth do you get for that investment, some of the factors today are not working in our favor, right?
• 18:07
  SPEAKER_00: Normally you get a bigger multiplier if you have slack in the economy, if interest rates are low, if there's more room for the stimulus to create a response, and if inflation's low, so central banks don't have to react to the stimulus.
• 18:21
  SPEAKER_00: Now, you think about all those things I just said and where we are today, you know, in the US, I would argue we don't have a lot of slack.
• 18:29
  SPEAKER_00: Maybe in some other places like Germany, we have a bit more.
• 18:32
  SPEAKER_00: But if we don't have a lot of slack, we do have inflation that central banks are responding to, and we have higher interest rates to get that return on your investment becomes significantly more difficult.
• 18:45
  SPEAKER_00: And so my fear is that today, while these initiatives will support growth, they might not support as much growth as it would have done, for example, if we've been making this investment coming out of a recession or in a recession when inflation was lower, interest rates were lower.
• 19:04
  SPEAKER_00: And given that the market, investors today are much more focused on these fiscal dynamics.
• 19:09
  SPEAKER_00: And we see that alive and well, especially recently in countries like France.
• 19:14
  SPEAKER_00: I worry that some of the spending is not going to get the effect that politicians want, and that investors increasingly, frankly, are punishing you if you are if you're campaigning on fiscal, more fiscal stimulus at this point.
• 19:28
  SPEAKER_03: If I could add quickly, historical studies of World War II and modern economic studies suggest that the growth effects or multiplier effects of defense spending in particular are relatively small.
• 19:44
  SPEAKER_01: Darrell, any thoughts on that one too?
• 19:46
  SPEAKER_04: No, nothing to add on that.
• 19:48
  SPEAKER_01: Other than that on that, all right.
• 19:49
  SPEAKER_01: And Barry, um, I'd like to stay uh or move over to the impact that, you know, is sticking to the point that we were talking to earlier about the US and its role in the global markets.
• 20:06
  SPEAKER_01: How do these changes in bond yields impact developing countries?
• 20:10
  SPEAKER_01: I'd be curious just to get your take on what that looks like.
• 20:14
  SPEAKER_03: It depends on uh what developing country you're talking about, of course.
• 20:18
  SPEAKER_03: Uh some emerging markets and developing countries are are immune to changes in U.S.
• 20:26
  SPEAKER_03: yields and to the strength or weakness of the dollar.
• 20:30
  SPEAKER_03: Um, South Korea and Taiwan are projected to grow at double-digit rates over the next year.
• 20:36
  SPEAKER_03: But I think the majority of developing countries, poor countries whose debts are still heavily denominated in dollars, increases in US yields translate directly into increases in their external debt servicing costs in magnified fashion.
• 20:55
  SPEAKER_03: So I think the rise in in US yields is bad news for the majority of emerging markets.
• 21:05
  SPEAKER_01: Then of course, then they're already facing higher costs for things from food to fuel as well.
• 21:10
  SPEAKER_01: So that's a challenge.
• 21:12
  SPEAKER_04: I'd add briefly to that as well, and totally in line with what Barry said.
• 21:17
  SPEAKER_04: The uh US treasuries are the global yield benchmark.
• 21:21
  SPEAKER_04: Everything is measured relative to US treasuries for good reason because of the ability to substitute and the central role of the dollar.
• 21:29
  SPEAKER_04: In fact, many emerging market economies issue in dollar, it's the most popular currency in which to issue, other than one's domestic currency for both corporates and governments by far.
• 21:43
  SPEAKER_04: And when the when US treasury yields go up, the entire uh regime of global bond market yields are going up almost in tandem.
• 21:56
  SPEAKER_01: Daryl, just oh yes, yeah, Rebecca.
• 21:58
  SPEAKER_00: Oh, I was just gonna say the big deal.
• 22:00
  SPEAKER_00: There for capital flows is that if I can get, let's say, a 5% yield on the U.S.
• 22:07
  SPEAKER_00: Treasury, which historically is seen as a safe investment, we will always pay our debts.
• 22:12
  SPEAKER_00: The Federal Reserve will intervene if there is a systemic issue.
• 22:17
  SPEAKER_00: So if I'm comparing that yield and that safety and that liquidity with an emerging market government bond, I'm going to be saying, what's the trade-off and is it worth taking the risk owning the emerging market bond?
• 22:30
  SPEAKER_00: So as long as the US bond market is perceived as a safe liquid market, I think it still is today, but we need to keep an eye on that.
• 22:39
  SPEAKER_00: Then the higher the US yield goes, the harder the trade-off is to lure capital to these emerging market countries.
• 22:47
  SPEAKER_00: And so when those countries don't receive the same capital inflow, not only does that lack of demand risk pushing up their bond yields, but it also tends to lead to weaker currencies.
• 22:59
  SPEAKER_00: So in a place like Brazil, for example, if you have a combination of higher bond yields and a weaker currency, it can create contagion risks that hurt the broader financial market.
• 23:10
  SPEAKER_00: And the weaker currency can actually be something that supports local inflation, then the central bank has to raise rates.
• 23:17
  SPEAKER_00: So they can get into a pretty negative spiral pretty quickly.
• 23:21
  SPEAKER_00: And you have seen historically when you have a strong dollar regime, which not always, but often goes hand in hand with higher US yields, that tends to be an environment where emerging markets underperform the US pretty consistently over history.
• 23:39
  SPEAKER_01: Great point.
• 23:40
  SPEAKER_01: Is there anything that emerging markets can do in that situation to improve their ability to maneuver?
• 23:49
  SPEAKER_00: I mean, it's it's really interesting.
• 23:52
  SPEAKER_00: The last decade or so, you have seen a lot, not all, but a lot of emerging markets focusing on improving their own fiscal house, uh, getting their fiscal house in order.
• 24:04
  SPEAKER_00: And so they were less vulnerable.
• 24:06
  SPEAKER_00: They've been issuing less debt in dollars, more in local currencies, and there's been enough demand.
• 24:11
  SPEAKER_00: And so that does make them, relatively speaking, less vulnerable.
• 24:15
  SPEAKER_00: I would point to Brazil's latest election at the second round, just at the end of October.
• 24:21
  SPEAKER_00: To me, a fascinating election because Bolsonaro, who lost unexpectedly in the second round, he was seen as the more fiscally responsible candidate versus Lula.
• 24:34
  SPEAKER_00: We'll see what actually happens.
• 24:36
  SPEAKER_00: But when Lula won, he's seen as someone who's relatively more likely to spend money, which would support growth, but it would also support inflation.
• 24:45
  SPEAKER_00: It would push up bond yields.
• 24:47
  SPEAKER_00: And the worries there have gotten so acute that when Lula won, all the markets in Brazil sold off aggressively.
• 24:54
  SPEAKER_00: And there are now heightened worries that they could get a credit rating downgrade because of these dynamics.
• 25:01
  SPEAKER_00: And so it to me is just a great example of what can turn when a country's fiscal dynamics have gotten to a point where if you don't have austerity, even though it'll slow growth, no one wants your assets anymore.
• 25:16
  SPEAKER_04: I'd like to jump in quickly on that, Courtney.
• 25:19
  SPEAKER_04: You asked what, you know, what can uh governments do?
• 25:22
  SPEAKER_04: There's actually a proposal in Brazil, uh, jumping on Rebecca's point, radical proposal by Andre Lara Rezenda to for the central bank to lower interest rates in order to reduce government deficits, overcome, you know, even in the face of inflation above target.
• 25:45
  SPEAKER_04: Uh with the idea being that the government is so constrained and threatened, as Rebecca said, uh, by downgrades and fiscal constraints, that the urgency is to reduce government expenses by lowering its interest expense, even at the risk of creating later inflation.
• 26:05
  SPEAKER_03: We have to encourage our Brazilian friends to look to the experience of, say, Turkey, where it's been tried and failed.
• 26:16
  SPEAKER_01: You answered my question, which was what do you think about that?
• 26:21
  SPEAKER_04: So John Cochran wrote about it yesterday, and he said there's arguments both ways, uh, given the urgency of the situation in Brazil.
• 26:28
  SPEAKER_04: It's a so it's a somewhat different situation than Turkey.
• 26:30
  SPEAKER_04: But I uh, you know, I I would also question them.
• 26:33
  SPEAKER_04: It's pretty radical, but it's well, it's well considered um by Rosenda.
• 26:39
  SPEAKER_01: Well, Daryl, that that brings up a question that we were talking about earlier when we were preparing for this conversation, which is about speed in bond market crises.
• 26:49
  SPEAKER_01: So could you just talk a little bit about how long it takes for crises to emerge, how much time a government might have to employ a plan for intervention?
• 27:00
  SPEAKER_01: And I'm curious too, does technology play a role at all in in these crises?
• 27:06
  SPEAKER_04: Courtney, if I may, uh I'd like to show one picture because I think picture does say a thousand things.
• 27:10
  SPEAKER_01: Yes, please.
• 27:12
  SPEAKER_04: So this is a chart.
• 27:13
  SPEAKER_04: Let me see if I can make it full screen.
• 27:19
  SPEAKER_04: Well, it looks good.
• 27:21
  SPEAKER_04: I think everybody can see it.
• 27:23
  SPEAKER_01: We can see it well.
• 27:24
  SPEAKER_04: It's the three most important uh developed market bond crises of the last 40 years.
• 27:30
  SPEAKER_04: Uh Italy uh during the European sovereign debt crisis from June to November 2011, the United States, and the same Carville comment I made earlier about President Clinton's problems.
• 27:43
  SPEAKER_04: Uh that was the 1993 to 1994 bond market massacre.
• 27:48
  SPEAKER_04: And then the guilt crisis that we discussed at the beginning, Courtney, in or during which uh guilt yields, at these are all 10 years, jumped by over 100 basis points.
• 27:59
  SPEAKER_04: And if you look at the vertical axis and these three crises, you might say, well, the guilt crisis was the most benign, and the Italian and US crises were much more severe.
• 28:11
  SPEAKER_04: But then look at the time horizons over which these crises appeared.
• 28:16
  SPEAKER_04: So the US had almost a year to deal with its crisis, Italy had about five months, and the UK government had four days, four business days during which it had to deal with huge bond market turmoil.
• 28:32
  SPEAKER_04: And it was unable to do that.
• 28:34
  SPEAKER_04: The government had to resign, the Bank of England had to step in aggressively and buy uh guilt bonds in order to bring the guilt market uh back into place.
• 28:45
  SPEAKER_04: And the government eventually had to later had to retreat on its budget.
• 28:49
  SPEAKER_04: So the speed the speed of arrival of these shocks, the how fast the information comes into the market and the resiliency of the market to handle it over a few days is really extremely important.
• 29:04
  SPEAKER_04: So a major geopolitical crisis, a COVID shock like we saw in March of 2020, which did for a few days destabilize the treasury market.
• 29:13
  SPEAKER_04: Uh these these are the ones that you, if you're really worried about a systemic crisis, these are the ones that can uh really unhinge the global financial system.
• 29:24
  SPEAKER_04: As far as uh what can be done, uh I think technology is only up the ante on speed.
• 29:31
  SPEAKER_04: For example, we're moving towards 24-7 markets.
• 29:35
  SPEAKER_04: And that's happening even before tokenization, which will make continual uh global bond markets a reality within 10 to 15 years.
• 29:45
  SPEAKER_04: And so governments will have less uh breathing space overnight and over weekends to get their houses in order, and bond market dealers uh will be in continuous turmoil during these crises as as markets become 24-7 uh with new technology.
• 30:02
  SPEAKER_04: And also, of course, communication systems are um bring the crisis to the door of everybody instantly.
• 30:08
  SPEAKER_04: So, yeah, technology matters, but I think it's actually really the speed of the macro shock and the intermediation capacity of the market to handle it uh that that matter the most.
• 30:20
  SPEAKER_01: I'm just going to, for those listening, just get in another few questions.
• 30:24
  SPEAKER_01: So I'll do one more regular question and then a quick round, and then we'll we'll open it up to QA.
• 30:30
  SPEAKER_01: So if you're listening and you have any questions, please feel free to put them in the QA box and I'll and we'll get to them.
• 30:35
  SPEAKER_01: Um so, Rebecca, I just wanted to close with a little bit more current events as well.
• 30:40
  SPEAKER_01: You've written about Gulf Capital potentially shifting towards domestic needs amidst the ongoing fighting in the region.
• 30:47
  SPEAKER_01: Um, there's been a lot of chatter about renewed attacks on Iran after the midterms.
• 30:52
  SPEAKER_01: How might the bond market effects run through energy prices and investment flows?
• 30:57
  SPEAKER_01: What are you doing?
• 30:58
  SPEAKER_00: Yeah, so I sure.
• 31:00
  SPEAKER_00: So it's important to understand that in the Gulf region over the last decade, a number of these countries have meaningfully increased the assets managed by sovereign wealth funds, so government-tied entities.
• 31:14
  SPEAKER_00: And these are different from central banks, which tend to be low-risk, sticky holders of safer assets like bonds.
• 31:22
  SPEAKER_00: When we're talking about the sovereign wealth funds of things like the Saudi Arabia and UAE, well, they do own some bonds.
• 31:29
  SPEAKER_00: It's primarily going to be private assets, public equities, assets that are going to get them higher returns.
• 31:36
  SPEAKER_00: That said, I do think this flow of funds is an important thing to watch right now for the bond markets and the markets broadly.
• 31:45
  SPEAKER_00: You know, Saudi Arabia, UAE are the two biggest, but the region overall manages the estimates are somewhere between four and six trillion dollars.
• 31:53
  SPEAKER_00: And just last year, the estimate is that this region's sovereign funds invested more than$120 billion.
• 32:00
  SPEAKER_00: The U.S.
• 32:00
  SPEAKER_00: was the biggest single recipient of that money.
• 32:03
  SPEAKER_00: So if these countries are saying, okay, we aren't getting the same revenues that we expected either from energy and or from international business and tourism, and we need more capital to uh repair infrastructure that was damaged in the war or shore up our budget balances, there's less capital that can go out to make some of these investments.
• 32:28
  SPEAKER_00: And then you have the feedback loop.
• 32:30
  SPEAKER_00: If the US is getting less of that capital, and interesting, in recent years, a lot of that uh Gulf money went to AI companies, both directly and indirectly through U.S.
• 32:42
  SPEAKER_00: investment firms.
• 32:43
  SPEAKER_00: So if the AI firms aren't getting that capital, that means all else equal, they're probably going to have to issue more debt to finance their growth.
• 32:51
  SPEAKER_00: If they're issuing more debt to finance their growth, we have greater competition for other corporate bonds.
• 32:57
  SPEAKER_00: And again, at the margin, I agree with that point.
• 32:59
  SPEAKER_00: This is small compared to the bond issuance, but it's still a marginal source of competition.
• 33:04
  SPEAKER_00: So that's the primary reason I'm keeping a close eye on this.
• 33:08
  SPEAKER_00: And I think the longer the war goes, um, and especially if oil prices are high but not rising sharply, so they get more money for each barrel that gets through, uh, the greater the risk that they're gonna have to slow the amount of capital being invested overseas.
• 33:22
  SPEAKER_00: The capital will still flow.
• 33:24
  SPEAKER_00: It's just a matter of degree, but it's such an important source of capital that it can have global implications.
• 33:32
  SPEAKER_01: Great.
• 33:33
  SPEAKER_01: What I'm going to do now, I just want to talk really briefly about solutions and just walk this through like 90-second answers for each of you.
• 33:40
  SPEAKER_01: And then we'll just do a lightning round.
• 33:42
  SPEAKER_01: But Daryl, what do you think is the most useful change to um to make government bond markets more resilient and who would need to implement it?
• 33:51
  SPEAKER_01: And we can kind of use the US, I guess, as a basis, unless you feel like you want to use smarts.
• 33:58
  SPEAKER_04: The US is the most important anyway.
• 33:59
  SPEAKER_04: Well, this the smart Alec answer is to have a government issue less bonds.
• 34:04
  SPEAKER_04: But and I think you're probably talking about the market design.
• 34:07
  SPEAKER_04: And there are some plumbing things that are really important.
• 34:11
  SPEAKER_04: Recently in the United States, central clearing of the treasury market was required.
• 34:16
  SPEAKER_04: And there's a lot of details that I won't get into.
• 34:19
  SPEAKER_04: That's now being considered in other countries, and I think it's has been really important.
• 34:23
  SPEAKER_04: We also depend so heavily on a small number of large primary dealers that would help to redesign the market so that buy-side firms could buy and sell directly with other buy-side firms in addition to getting liquidity from large dealers.
• 34:40
  SPEAKER_04: So that would be an all-to-all market would help a lot there.
• 34:44
  SPEAKER_04: Those are the two items I'd mentioned, but come back on another day and I have a whole list of other things.
• 34:50
  SPEAKER_01: All right.
• 34:50
  SPEAKER_01: Barry, alongside Daryl's suggestions, what fiscal step would you put first to preserve a government's capacity to act?
• 34:59
  SPEAKER_03: Errol is the um master of plumbing, so I won't comment on that.
• 35:03
  SPEAKER_03: But uh I I think the smart Alec answer should be taken seriously, that addressing the death deficit problem in the United States would do more than anything else to reassure investors, reassure the markets.
• 35:18
  SPEAKER_03: And to my mind, uh the one good thing that can be said about Doge uh is that it reminded us that we cannot meaningfully address the deficit problem by eliminating waste and fraud from government spending.
• 35:33
  SPEAKER_03: We have to think seriously about the revenue side of the um federal accounts, which I think means closing loopholes, uh raising marginal rates, at least modestly in progressive fashion.
• 35:49
  SPEAKER_03: Finally, um Courtney, you mentioned earlier that the Treasury had updated its guidance to dealers in government securities uh earlier today.
• 36:02
  SPEAKER_03: Treasury Secretary Bessant has been uh trying to save on uh debt service and costs by issuing more short-term debt, uh short-term rates being lower at the moment than longer-term rates.
• 36:17
  SPEAKER_03: I think that creates risks as well.
• 36:21
  SPEAKER_03: The possibility of uh uh interest costs can go up with inflation more rapidly if more of the debt is short-term.
• 36:32
  SPEAKER_03: A lot of short-term debt can create problems for those uh same dealers that Daryl was talking about.
• 36:41
  SPEAKER_03: So I think the Treasury ought to be balancing the immediate cost savings against the risks when it goes down the short-term debt road.
• 36:51
  SPEAKER_00: I guess if I'd add anything, I I agree with everything that's been said.
• 36:56
  SPEAKER_00: It you know, the 2028 campaign has started already, whether we like it or not.
• 37:02
  SPEAKER_00: And one thing that I'm hearing more of today that I hadn't heard for the last few years is fiscal discipline.
• 37:13
  SPEAKER_00: Now, it might just be people seizing the moment and thinking this will land well with voters, but Rahm Emanuel, and I'm just picking on him because he's an extremely vocal would-be candidate, uh, was talking about reinstituting pay as you go.
• 37:28
  SPEAKER_00: So, to the degree that the Democrats, for instance, would want to spend more, they would have to figure out how they're paying for it.
• 37:35
  SPEAKER_00: So we're not adding to the deficit anymore.
• 37:37
  SPEAKER_00: So I'm gonna be keeping my ears open in the coming weeks to both sides of the aisle to see if this election result changes the logic on any of that.
• 37:47
  SPEAKER_00: Obviously, voters want the cost of living to come down, but the cost of living, part of that is getting bond yields down.
• 37:54
  SPEAKER_00: So people can afford to get a mortgage for a home, they can afford to get an auto loan, et cetera.
• 37:59
  SPEAKER_00: So so I'm gonna keep a close eye on that.
• 38:01
  SPEAKER_00: And I agree completely with the comments that Barry and Daryl made.
• 38:06
  SPEAKER_01: All right, thank you.
• 38:07
  SPEAKER_01: And our last, we'll do just a very quick lightning round and we'll work backwards.
• 38:12
  SPEAKER_01: So we'll do Rebecca, Barry, Daryl.
• 38:15
  SPEAKER_01: What metric or threshold or thing are you keeping an eye on just to ensure that things are going in the right direction as opposed to the wrong direction?
• 38:26
  SPEAKER_01: What's sort of like the big thing that you think we should be really paying attention to?
• 38:31
  SPEAKER_00: So I think this is a low probability.
• 38:35
  SPEAKER_00: And we were talking about it a little bit before we started today.
• 38:39
  SPEAKER_00: Uh, we're gonna have a lame duck session beginning that runs until the new Congress is seated on January 3rd.
• 38:46
  SPEAKER_00: And there is a possibility that the outgoing Republican Congress may want to try to pass a reconciliation bill while they still have leverage within Congress.
• 38:56
  SPEAKER_00: It may be relatively benign in terms of what they want to spend on.
• 39:00
  SPEAKER_00: Obviously, we need money for the Pentagon.
• 39:03
  SPEAKER_00: Uh, I think they've promised more money for farmers, for example.
• 39:07
  SPEAKER_00: Is it a relatively small amount that bond markets can absorb, or is it going to be bigger?
• 39:13
  SPEAKER_00: The wild card I've heard about is a preemptive increase in the debt ceiling to the tune of around$5 trillion.
• 39:20
  SPEAKER_00: The signaling of that would be very worrisome for me, especially because bond market liquidity towards year end tends to get more spotty.
• 39:29
  SPEAKER_00: So you could see more volatile reactions in the market to an announcement like that, which I would liken a teeny bit to the Liz Trust moment in the UK in 2022.
• 39:40
  SPEAKER_00: So don't take your eyes off the ball just because we finished the midterm election.
• 39:44
  SPEAKER_00: I think but now through the end of the year and that lame duck session.
• 39:48
  SPEAKER_00: I just want to see that go quietly, smoothly, and without any fiscal surprises.
• 39:56
  SPEAKER_03: I would be looking at the convenience yield on uh U.S.
• 40:01
  SPEAKER_03: Treasury securities.
• 40:02
  SPEAKER_03: That's a fancy way of saying the borrowing advantage the Treasury has because the dollar and U.S.
• 40:10
  SPEAKER_03: Treasuries have traditionally, historically, been viewed as a safe haven.
• 40:15
  SPEAKER_03: Uh, so there's additional demand for them out there in the world.
• 40:20
  SPEAKER_03: Uh the cost to the Treasury is lower when it borrows than would be the case otherwise.
• 40:25
  SPEAKER_03: Is that convenience yield disappearing because people are rethinking the role of the dollar in U.S.
• 40:32
  SPEAKER_03: Treasuries as a safe haven?
• 40:35
  SPEAKER_01: And Darrell.
• 40:37
  SPEAKER_04: I'll be very brief.
• 40:38
  SPEAKER_04: I would look at the Congressional Budget Office's projected jet debt to GDP over the next 30 years.
• 40:44
  SPEAKER_04: This is a long-term problem, in my view.
• 40:46
  SPEAKER_04: And I would look at the term spread of long-term U.S.
• 40:49
  SPEAKER_04: treasuries relative to short-term U.S.
• 40:52
  SPEAKER_04: interest rates to get a sense of whether the bond market is uh over uh, you know, the uh it's overwhelmed by the amount of issuance in the long term.
• 41:03
  SPEAKER_01: All right.
• 41:04
  SPEAKER_01: Thank you.
• 41:04
  SPEAKER_01: Daryl, uh Secretary Besson has been ramping up buybacks, but how much influence does the Treasury Department even have in calming yields?
• 41:12
  SPEAKER_01: The volume of the buyback seems to be minuscule relative to the size of the Treasury market.
• 41:17
  SPEAKER_01: So I wonder about the signaling versus actual impact of Treasury Department's actions, in this case, the buybacks.
• 41:23
  SPEAKER_04: Yeah, Secretary Besson even himself later agreed that the buybacks are not large enough to really control Treasury yields, and that he meant it more as a signal of what he believed the appropriate yields to be.
• 41:37
  SPEAKER_04: But as I mentioned at the early part of our discussion, the bond market is far more powerful than anything the Treasury could do, at least in the size range that buybacks were.
• 41:48
  SPEAKER_04: He increased them from four to the range of six to eight billion dollars.
• 41:54
  SPEAKER_04: And you know, the U.S.
• 41:55
  SPEAKER_04: Treasury market is now$32 trillion.
• 42:00
  SPEAKER_04: Those buybacks at that at that scale, we're not gonna uh ever gonna make a difference.
• 42:08
  SPEAKER_01: A question here, and I'll give this to all of you.
• 42:10
  SPEAKER_01: I'll start with you, Rebecca.
• 42:11
  SPEAKER_01: Besides the U.S., which country's bond market should we be paying attention to right now and why?
• 42:19
  SPEAKER_00: France.
• 42:20
  SPEAKER_00: France is my easy number one answer to that, and it's been my answer for the over the last year.
• 42:26
  SPEAKER_00: And I say that partly because some of the dynamics we're talking about in the US are true there.
• 42:32
  SPEAKER_00: You have voters who want the government and expect the government to help address affordability, cost of life issues.
• 42:40
  SPEAKER_00: And the government literally doesn't have fiscal room to do that.
• 42:43
  SPEAKER_00: And so anytime a new government comes in and says, well, we're gonna raise the pension age by two years, or we're gonna take a few steps to get the budget deficit under control, they get voted out.
• 42:52
  SPEAKER_00: So we've had six prime ministers in France in five years.
• 42:56
  SPEAKER_00: So the politics are problematic.
• 42:59
  SPEAKER_00: But what's different about France from, say, the United States, a few things.
• 43:03
  SPEAKER_00: One, they don't control their own currency, right?
• 43:05
  SPEAKER_00: They're in the currency union.
• 43:07
  SPEAKER_00: And so weakening the currency to inflate away some of the debt is not an option.
• 43:12
  SPEAKER_00: They don't fully control their interest rates.
• 43:14
  SPEAKER_00: The ECB sets interest rates as a community.
• 43:17
  SPEAKER_00: And so if they would want a slightly different interest rate for their own situation, can't do that either.
• 43:24
  SPEAKER_00: And then finally, when you look at their bond market, it's quite a bit smaller than the US bond market.
• 43:30
  SPEAKER_00: And the foreign ownership of those bonds is relatively high.
• 43:34
  SPEAKER_00: And that just means that when there is a catalyst, the volatility in the bond market can be quite quick.
• 43:41
  SPEAKER_00: Now, there are the things that could help France.
• 43:43
  SPEAKER_00: So the European Central Bank, the ECB, has tools it can use to intervene in the French bond market and support it.
• 43:50
  SPEAKER_00: But those tools, at least on paper, have conditionality.
• 43:54
  SPEAKER_00: And right now, France doesn't meet any of the conditions.
• 43:57
  SPEAKER_00: So could they get bailed out if they need to?
• 44:00
  SPEAKER_00: Yes.
• 44:00
  SPEAKER_00: Is it going to be easy or straightforward or quick?
• 44:03
  SPEAKER_00: In my mind, no.
• 44:04
  SPEAKER_00: And what I worry about with France is that if France does see greater fiscal stress, we're going to have contagion to the rest of the world.
• 44:12
  SPEAKER_00: Now we have seen some safe haven flow into the United States bond market, I think tied a little bit to France, but I'm not sure how much of that we could count on at this point in the environment for our economy, for inflation, for the Fed, for fiscal.
• 44:28
  SPEAKER_01: Barry, what about you?
• 44:30
  SPEAKER_01: Which bond markets looking at?
• 44:32
  SPEAKER_03: I have nothing to add in part because France is at the top of my list as well.
• 44:36
  SPEAKER_03: And Rebecca has explained the situation well.
• 44:39
  SPEAKER_03: If you look historically, fiscal and financial crises tend to follow when you have a combination of chronic budget deficits, rise in global interest rates, and a weak government that doesn't have the wherewithal to systematically address the problem.
• 44:59
  SPEAKER_03: And if you look at timing, those fiscal and financial problems tend to erupt in the months leading up to an election, which is the other element at work in France.
• 45:11
  SPEAKER_01: Darrell, or do you agree?
• 45:12
  SPEAKER_01: Is there a distant second that you would add to that list?
• 45:16
  SPEAKER_04: France is clearly at the top of the list.
• 45:18
  SPEAKER_04: Japan is actually a looming problem because their yields are rising and uh and they have 249% debt to GDP in Japan.
• 45:28
  SPEAKER_04: That's more than double the US uh ratio.
• 45:31
  SPEAKER_04: So that's a that's been a uh problem on everyone's minds for 25 years.
• 45:36
  SPEAKER_04: France is the biggest one today, but Japan hasn't gotten away gone away.
• 45:43
  SPEAKER_00: And if we want to bring this home to the United States, the risk to the US and Secretary Bessant has definitely been involved in this.
• 45:52
  SPEAKER_00: Japan, one vehicle it can use to try to bring down its yields without doing something that could destabilize investor confidence in their bond market, is to sell some of their treasuries.
• 46:04
  SPEAKER_00: Japan today is, I believe, they passed China, they're the biggest foreign central bank holder of U.S.
• 46:09
  SPEAKER_00: treasuries.
• 46:10
  SPEAKER_00: They have large unrealized gains on their treasury holdings that they could monetize and they could sell some treasuries and use that capital to buy Japanese government bonds or JGBs and in that try to bring down the Japanese bond yield.
• 46:26
  SPEAKER_00: But doing that obviously would be very inconvenient for the United States.
• 46:29
  SPEAKER_00: So Scott Besson is trying very hard to convince Japan that that is not an ideal plan.
• 46:36
  SPEAKER_01: And what uh just really quickly, I'm curious because we didn't really get into this scenario, which I think is a very interesting one.
• 46:42
  SPEAKER_01: What do you make of that plan?
• 46:47
  SPEAKER_03: So I think the Japanese financial operations we saw over the summer were mainly designed to prop up the exchange rate and not directly deal with the rising yields to which you referred.
• 47:03
  SPEAKER_03: I was actually in Tokyo last week, and it's remarkable how weak the exchange rate is and how cheap everything is to uh to an American.
• 47:12
  SPEAKER_03: Um, but what happened there was, as you said, Secretary Besson basically told the Japanese it would be inconvenient for us if you supported your exchange rate by buying yen using your dollar reserves.
• 47:27
  SPEAKER_03: So instead, he offered them basically uh a credit line, a repo facility, and US Treasury sold euros out of its own exchange equalization uh fund.
• 47:42
  SPEAKER_03: I think the signal sent there was two other central banks and governments your dollar reserves are not as liquid and usable, as attractive as you previously thought, because the U.S.
• 47:55
  SPEAKER_03: Treasury would object if you actually make use of them.
• 48:00
  SPEAKER_01: All right.
• 48:01
  SPEAKER_01: Well, thank you for digging into that important case on the very few minutes.
• 48:05
  SPEAKER_01: I did promise that we would end a few minutes early, so I am going to make good on my promise.
• 48:10
  SPEAKER_01: Uh, but before I do so, I just want to let those listening that know that we do have additional programs.
• 48:16
  SPEAKER_01: We have in-person programs in New York.
• 48:18
  SPEAKER_01: We'll keep doing stuff online, so please join us.
• 48:21
  SPEAKER_01: Daryl, Rebecca, Barry, thank you.
• 48:23
  SPEAKER_01: This was fascinating.
• 48:24
  SPEAKER_01: I am awed by your tremendous knowledge and um and expertise, and I'm so grateful to you for sharing it with us today.
• 48:33
  SPEAKER_01: So thank you and um have a wonderful rest of your day.
• 48:38
  SPEAKER_01: Thank you.
• 48:38
  SPEAKER_00: Thanks, Barney.
• 48:39
  SPEAKER_00: Bye-bye.
• 48:40
  SPEAKER_00: Bye-bye.
• 48:48
  SPEAKER_02: Thank you for joining us for this episode on Global Insights.
• 48:52
  SPEAKER_02: You can subscribe to Global Insights on Apple Podcasts, Spotify, or wherever you get your audio.
• 48:58
  SPEAKER_02: For more analysis, events, and ways to connect with our community, click on the link in the description.
• 49:05
  SPEAKER_02: See you next time.