Global bond market sounds alarm! High government debt prompts "debt vigilantes" to counterattack.

Miller Overall, the previously almost resistance-free large-scale government bond issuances in major economies are now becoming the "battlefield" for bond vigilantes to question government overspending and inflation prospects. Cold auctions, sharp drops in long-term bond prices, and the dynamics in major bond markets globally are sending a clear signal that in the current uncertain environment, governments need to pay higher interest rates for borrowing in the next few decades. The U.S. 20-year bond sale on Wednesday was the first long bond auction after Moody's stripped the U.S. of its Aaa rating last week. However, the auction ended with a dismal result that no one wanted to see. The highest bid rate during the auction reached 5.047%, about 1.2 basis points higher than the pre-issue rate of 5.035%, the largest tail spread in nearly six months. The bid-to-cover ratio also dropped from an average of 2.57 over the past six months to 2.46. After the auction results were announced, the U.S. 30-year bond yield briefly skyrocketed to 5.1%, nearing a twenty-year high, and the 10-year U.S. bond yield also rose to 4.595%. Similar events are happening in Japan as well. In Tuesday's Japanese government bond auction, the average bid-to-cover ratio dropped from 2.96 last month to 2.5, with the 20-year Japanese government bond bid-to-cover ratio reaching its lowest level since August 2012. Another sign of weak demand is the tail spread reaching 1.14, the longest since 1987. After the auction results, the benchmark 10-year Japanese government bond yield briefly rose to 1.525%, the highest since the end of March, and the 20-year Japanese government bond yield surged by about 15 basis points to the highest level since 2000. In theory, governments can appease bond investors by reducing spending and increasing taxes, but given the shadow cast on economic growth prospects by Trump's trade war, tightening policies are hardly a viable option. Worries about Trump's trade war and tax cuts exacerbating inflation and forcing governments to increase spending have led to the majority of selling in U.S., Japanese, and British bonds focused on longer-term bonds. The yield on British 30-year government bonds has reached its highest level since the late 1990s. The yield on the U.S. 30-year government bond reached 5.09%, rising 70 basis points since March. Guy Miller, Chief Market Strategist at Zurich Insurance Group, said, "Investors believe that if we are in a world of ongoing debt deterioration and fragile growth momentum, then the risk premium we demand for holding these bonds should rise, and that is exactly what is happening now." In the coming weeks, Japan, Germany, the U.S., and the U.K. will issue 10-year and 30-year government bonds. Miller added, "Investors are questioning these issuances." Term Premiums The fundamental reason for bond sell-offs lies in the so-called "term premium" - the risk premium investors demand for holding long-term bonds. Currently, the term premium for the U.S. 10-year government bond is estimated at 0.79%. In the current environment, this level seems low - not only lower than the valuation when U.S. debt was at a similar level in 2011, but also significantly lower than the 5% during the stagflation of the 1970s. Therefore, analysts believe that the term premium for U.S. bonds may further increase. Rong Ren Goh, Portfolio Manager of the Fixed Income team at Eastspring Investments, said, "People are repricing term premiums. These concerns were previously lurking in your mind, but once they break out, they become a problem." Goh had planned to buy long-term U.S. bonds when the yield on the 10-year U.S. bond crossed 4.5% and the yield on the 30-year U.S. bond reached 5%, to increase the portfolio duration, but changed his mind after this week's news about the U.S. budget and Moody's downgrade. He said, "We are in the process of price discovery, which is unprecedented, so I won't rush to make long-duration investments at the current level." Probing and Adjusting By the end of 2024, the total U.S. federal government debt will be $36.2 trillion, with about $9 trillion held by foreign countries. In the latest 30-year U.S. bond auction, the participation rate of foreign investors (including central banks around the world) was only 58.88%, the lowest since 2019 and continuously declining since October last year. In addition to longer-term U.S. bonds, Japanese investors are also selling longer-term Japanese government bonds. Senior Fellow at the Brookings Institution, Robin Brooks, said, "More macro-economically, fiscal deficits are important, fiscal policy is important, and fiscal space is limited. And not just the U.S. has fiscal policy issues." In Japan, concerns in the bond market stem from the fiscal stimulus plan enacted by Japanese authorities before the July upper house elections, which may mean an increase in borrowing by the government as the Bank of Japan reduces its bond purchases. This raises the same question related to the term premium. The yield on 10-year Japanese government bonds is currently 1.55%, up 44 basis points since early April, further deviating from Japan's current policy rate of 0.5%. Masayuki Kichikawa, Chief Macro Strategist at Sumitomo Mitsui DS Asset Management in Tokyo, said, "The market expects the Bank of Japan to continue raising rates and reduce its holdings of Japanese government bonds. Many investors may be thinking about what level of yield is consistent with the policy rate, especially for ultra-long-term bonds, and without the support of the Bank of Japan purchases. We are in the process of finding this balance, it's a trial-and-error process." It is worth noting that Germany may become a beneficiary in this global bond repricing process. Despite the surge in German bond yields this year due to large-scale stimulus programs, Germany's debt-to-GDP ratio remains the only one below 100% among the Group of Seven (G7) countries. Indeed, during the global bond sell-off in April this year, investors turned to German government bonds for safety. Guy Miller added, "Germany may benefit from this global rebalancing of debt prices because it has a lower debt level." However, he also pointed out that the turmoil in the global bond market may continue for some time.Miller said, "Despite Germany's spending commitments, its debt level will still be relatively low, and growth may receive a boost in the long term.""Bonjour, comment a va?" "Hello, how are you?"