Concerns over US government debt and rising bond yields have revived talk of bond vigilantes – investors who hold governments to account by selling their bonds when they think they are borrowing too much.
The UK had its own encounter with them in 2022, during Liz Truss' mini-Budget. In the US, 10-year treasury yields have climbed back above 5% this year, reviving the same conversation on the other side of the Atlantic.
Yet for Richard Woolnough, who runs the M&G Optimal Income fund, vigilantes have never gone away.
“What did the bond vigilantes do to Greece? What did they do to Spain, to Italy, Argentina, Portugal? What did they do to the banking sector? They never went away,” he said.
Woolnough said vigilantes only ever turn up where there is enough debt to be worth analysing: “You only get vigilantes when you have excess debt, so it tends to be large, significant markets. It's excess careless lending, and then careless lending is discovered, and prices adjust.”
At the moment, all eyes are on France, a large borrower of the kind Woolnough described. Last month, French 10-year yields moved above Italy's for the first time in years, with Italy and Spain's spreads over Germany both tighter than France's.
“You look at the credit spread and the rating between so-called peripheral debt and France at the moment. That's a hot topic, so that fiscal discipline, that market discipline, is there.”
Ben Lord, who manages the M&G Global Corporate Bond Strategy, said there was no need to panic just yet, noting that although the idea of a government failing is a “nightmare”, it is not a scenario he sees as possible in the immediate future.
Still, he expected the pressure from bond markets to continue and said he would be “astonished” if any government was surprised by “bump bond issuance or difficult times in bond markets”.
“If it does get bad, that's when reform happens, that's when governments get serious,” he concluded.
An example of this is the UK. As vigilantes have moved to Europe, they have seemingly moved away from the domestic market, where Woolnough noted the authorities have responded pre-emptively to fiscal concerns by shifting away from long-dated gilt issuance.
Ten years ago, there was very strong demand for this type of bonds, typically from pension funds and UK insurers looking to hedge really long-term liabilities, as Miles Tym, who manages the M&G Gilt & Fixed Interest Income fund, explained.
“The government issued an awful lot of long-dated gilts because there was big demand for them. As that demand has gone away, the duration and the term of what's being issued has shortened dramatically,” he said.
The shift shows up most clearly in how much of new issuance now counts as “long” – bonds maturing in more than 15 years. Five or six years ago, these accounted for as much as 30% of gilt issuance, with many of those bonds stretching out to 30, 40 or even 50 years. Today, only around 10% of issuance falls into the long category, and even those bonds only just qualify, maturing in around 15 years.
He noted: “Ten years ago the average duration of the nominal gilt market was about 12 years, it's now down to about seven and a half.”