The turmoil in the UK bond market threatens not only the stability of the country’s financial system but also the economic and social well-being of most of its citizens. It is a situation that is going from bad to worse, and other countries must watch it carefully. Underpinning the recent disruption is the reemergence of the bond vigilantes — a debt-disciplining financial force that, long repressed, is starting to reassert itself.
The UK narrative is well known by now. A “government in a hurry” goes all out and promises not just protection from higher energy prices for both households and companies and growth-enhancing structural reforms but also large unfunded tax cuts. It does so in the context of a global increase in borrowing costs. Not surprisingly, markets push back strongly against the implied increases in the amount of debt, interest payments and debt-to-GDP ratio. The resulting sharp surge in yields exposes the significant fragility of a pension system that resorted to financial engineering to enhance returns.