Gilt trip

The term “bond vigilante” has been tossed about lately, as fears arise about the sustainability of government debt burdens. The UK, in particular, has been on the receiving end of these narratives. Bond vigilantes are hard to distinguish from normal bond investors who are simply reacting to traditional economic cycles or allocation needs. So, what exactly distinguishes a bond vigilante?

Perhaps the one main distinction that separates a vigilante bond seller from an everyday investor, is that they sell in protest. Bond vigilantes typically sell government debt securities to dissent from irresponsible government spending proposals. To be sure, bond vigilantes are not motivated by civic duty nor are their protests without financial risks. Their efforts are commonly confronted by a country’s central bank, which can ultimately lead to devastating losses for the vigilantes. However, this group of bond sellers does serve as an effective check-and-balance party to out-of-control government spending.

Bond vigilantes have influenced government policies for decades, particularly in emerging market countries. This dynamic can also occur in developed markets as well. In 2022, they played a significant role in the United Kingdom reversing a “mini-budget” proposal that incorporated unfunded tax cuts. Their relentless selling of British government bonds (gilts) led to a sharp surge in borrowing costs and a collapse of the British pound to a 37-year low. These efforts also ultimately led to the resignation of former Prime Minister Liz Truss, who had been in office for a mere 44 days.

Unfortunately, the UK seems to be a favored target for this particular group of sellers, as they have once again homed in on a UK budget. In late October 2024, Chancellor Rachel Reeves introduced ambitious upfront public spending that was masked by significant future tax increases. This combination of “spend now, pay later” in an already-weak growth environment did not bode well with the global bond community. After an initial violent market response, everything seemed to quieten down; gilts actually rallied throughout the month of November. Then December arrived, and it was almost as if a collective organism made up of global bond sellers joined up against UK government bonds, sending yields soaring to levels not seen since the 2008 financial crisis.  

Were these the legendary bond vigilantes? It is actually very hard to distinguish vigilantism from normal investor behavior, but one good tell is when a country’s currency is losing value even though its borrowing costs are spiking higher, which is exactly what happened in December 2024. To be fair, there were also external factors contributing to a rising US dollar and higher global yields in general.

For the time being, the sense of a pending debt crisis in the United Kingdom has subsided, and gilts are back to trading in line with their global counterparts. However, borrowing costs remain generally elevated, and long-term growth prospects are a big unknown. The question is not whether change is needed, but whether those changes will be made before the Bond Vigilantes strike again. Until then, the new UK fiscal plan is “Gilty as charged”!