The recent spike in the 30-year Gilt yield may be instructive: the pressure on bond markets, where governments are not controlling their borrowing, is rising. The signalling mechanism is critical for bond yields. Yesterday’s opinion piece penned by the incoming Chancellor Kwasi Kwarteng warned that fiscal responsibility would remain far down the list of priorities.
Liz Truss’ plans to cap annual electricity & gas bills could cost £130bn over the next 18 months, according to policy documents seen by Bloomberg. On top of this, the government is planning a £40bn energy aid package for UK businesses. This does not include the tax cuts that Liz Truss promised during her campaign, costed by the OBR somewhere in the region of £30bn, possibly more.
The instantaneous implied real forward curve (gilts) has shifted up over the past month. The real yield on 20-year Gilts is back in positive territory (0.22% yesterday). The Bank of England will have to continue hiking aggressively. Jerome Powell has set the standard. Other Central Banks will follow, signalling that there will be no immediate rate cuts once terminal rates are reached. Bank rate may have to eventually move up to 4.5-5.0%.
Support for households during the pandemic has raised expectations regarding the role of government in future crises. Energy companies have piled political pressure on the government to introduce ‘Covid-style’ support schemes to help businesses survive the energy crisis. The pandemic has set a precedent: with this new, flawed narrative, governments can and should respond to ‘exogenous’ shocks with huge fiscal stimulus packages. Macroeconomic policy should protect businesses and consumers from unforeseen events at all costs. The ‘trade-offs’ that accompany policymaking are being completely ignored by governments.
If the world is indeed becoming a riskier place, there will be more crises over the next decade, including from climate change. If governments can spend ad infinitum to simply delay the cost of paying for these exogenous shocks, then a key constraint on macroeconomic policymaking disappears. If government spending becomes a backstop for any risk that can be borne by market economies, then the bond market, if it is indeed a disciplining mechanism, could react violently.
