Ed Monk, Associate Director, Fidelity International comments as US bond traders sound the alarm over tax cuts and credit downgrades. Ed’s full comment can be seen below.
“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 is 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.
While some of this elevated yield on American government bonds, or ‘treasuries’, may be down to the ‘flight from the dollar’ prompted by the recent trade environment, this spike in yields follows a downgrade by Moody’s, which removed the US’s AAA credit rating, citing over a decade of rising debt and interest costs. The US had held a Moody’s AAA rating since 1917.
Economists worry that when a rise in yields coincides with increased borrowing, interest payments on the debt can grow significantly. The latest tax cuts are expected to widen the US budget deficit, as they are not matched by spending cuts.
Some of the rise in yields is likely to due to 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. Some may also reflect concerns about inflation, as the tax cuts increase consumer spending power.
Implications for UK borrowing and global markets
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 Treasury that it will cost 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 mini-budget.
Indirectly the effects also feed into the cost of other forms of borrowing, such as mortgages.
Neither do the effects of higher US borrowing costs 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.
Bitcoin nears all-time high
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 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.
Commodity prices signal calmer outlook
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.”
