Bond markets take fright again over US borrowing – the week ahead

Important information -  the value of investments and the income from them can go down as well as up, so you may get back less than you invest. 

The world’s two most important financial markets are, not for the first time, shouting two different messages.

America’s principal stock market index, the S&P 500, is within a whisker of 6000, not far from its record closing level of 6144 reached on 19 February. It is saying, in effect, that the tariff crisis appears to be over, and we can all breathe a sigh of relief.

The US bond market, by contrast, is signalling distress. It is telling the American government that if it wants to borrow for 30 years it will have to pay 5% a year for the privilege. This is the level that, a week after ‘liberation day’, made Donald Trump blink and pause some of the biggest tariffs.

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While some of this elevated yield on American government bonds, or ‘treasuries’, may be down to the ‘flight from the dollar’ prompted by the tariffs, the latest rise in yields follows a downgrade by a major credit rating company - Moody’s - last week and progress in the US Congress towards the passing of a bill that includes tax cuts.

Moody’s stripped America of its perfect ‘AAA’ rating over what it called ‘over a decade’ of rising government debts and interest payments. The other two main ratings agencies had already made similar cuts, Fitch in 2023 and Standard & Poor’s in 2011. The US had enjoyed an AAA rating from Moody’s since 1917.

We’ll have to wait and see whether President Trump again reacts to the breaching of the 5% level of yield on government debt. Economists worry that when a rise in yields coincides with increased borrowing, the interest payments on the debt can spiral uncontrollably. And the latest tax cuts are expected to increase America’s already huge budget deficit because they are not matched by spending cuts.

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Some of the rise in yields are likely to be a simple reflection of the increased supply of government bonds as the US Treasury issues more of them to fund the tax cuts – more supply means a lower price, and bond yields and prices move in opposite directions – while some may be down to fears of increased inflation as the tax cuts give American consumers more money to spend.

If this all feels a bit remote from our concerns here in Britain, the fact is the yield on American government bonds is the global benchmark for borrowing costs, so what the American government pays to borrow influences the yield on British government debt (‘gilts’) too. Currently the markets are telling the Chancellor that it will cost her almost 5.5% to borrow for 30 years. The cost for 10-year gilts is 4.7% – uncomfortably close to the levels seen during the Liz Truss mini-budget crisis. Any rise in the cost of government borrowing lessens the Chancellor’s room for manoeuvre.

Indirectly the effects also feed into the cost of other forms of borrowing, such as mortgages.

The effects of higher US borrowing costs do not end there. A rise in yields makes bonds more attractive for new investors (as long as they are not too concerned about the implications for inflation), so some investors will decide to buy bonds instead of shares, potentially dampening the stock market.

Away from America, investors will be keen to see the details of the new EU-UK deal due to be announced today. The deal reportedly includes a defence pact and if this means that British arms companies will be able to participate in an EU-wide procurement programme, investors can be expected to cheer the news. There was little reaction today on the stock market, however – shares in BAE Systems, for example, had shed 1.3% by mid-morning.

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Away from the stock and bond markets, the most dramatic moves in recent weeks have been in the price of Bitcoin, which has soared from lows of $77,000 after the initial euphoria following Mr Trump’s election died down to $103,000 today, a level not far from its record high of about $108,000 in January. At times the cryptocurrency has tended to move in line with tech stocks and the recent recovery closely mirrors that of the Nasdaq index of US technology companies. The executive order signed by Mr Trump in March to establish a ‘strategic reserve’ of Bitcoin also provides support for the price.

Gold and oil can also send signals about the health of the global economy. Both markets have calmed down after dramatic price moves at the height of the tariff drama: gold was trading at about $3,240 an ounce this morning, some way below recent peaks, while oil has recovered from lows of about $60 a barrel to trade at $65 today. The gold price suggests that fears of a financial crisis prompted by the tariffs have abated while oil is signalling that earlier fears of a recession globally or at least in the US have likewise diminished, even if they have not disappeared entirely.

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