Chancellor keeps bond market vigilantes onside but still has more work to do

• Benchmark 10-year gilt yield is barely changed during the week of the Spring Statement
• UK 10-year yield has shown greatest increase among G7 since Labour's election win
• US has shown minimal increase even though it faces similar borrowing challenges to the UK
• Trump and Bessent's focus on the bond rather than the stock market seems to be working

"The Chancellor of the Exchequer has not pleased everyone with her Spring Statement but the UK government bond, or gilt, market seems settled enough, as the yield on the benchmark 10-year issue around 4.75% and Rachel Reeves will doubtless draw some comfort from that," says AJ Bell investment director Russ Mould.

"However, the chancellor still has much work to do, since the 10-year yield is up by 58 basis points (0.58%) since Labour's election win last July and that is the greatest advance across the G7 using that metric across that period.

"The increase in the yield on 10-year Japanese Government Bonds (JGBs) is much worse in percentage terms, but the chancellor will clearly have to stay alert if she is to keep bond vigilantes at bay and avert any chance of a repeat of autumn 2022's gilt market volatility during the short-lived Truss-Kwarteng administration.

"Fixed-income markets clearly remain wary of any sudden policy moves that could increase the national deficit at a faster-than-expected rate, while inflation continues to run above the Bank of England's target of 2%, to provide an additional complication.

"At least the prevailing 10-year gilt yield looks defensible in the context of the Office for Budget Responsibility's 2025 forecasts for GDP growth and peak inflation of 1.0% and 3.8% respectively, since adding those numbers together is often used as a means of judging what the 'neutral' rate should be.

Source: LSEG Refinitiv data

"Nevertheless, the chancellor could be forgiven for casting an envious glance across the Atlantic, where President Trump and Treasury Secretary continue to hold 10-year Treasury yields in check, even if America faces a debt dilemma that is very similar to the one over here.

"Stock markets do not seem happy, as the NASDAQ Composite, S&P 500 and Dow Jones Industrials sit at the bottom of the performance tables for major equity indices in 2025 to date, in a marked turnaround from the past few years.

"The US fixed-income market seems much more sanguine, because it is here that Trump, Treasury Secretary Scott Bessent may be focusing their attention anyway. The US 10-year yield has barely flickered since last summer, or indeed since America's presidential election last November.

Source: LSEG Refinitiv data

"Thus far, Trump seems impervious to stock market volatility, in contrast to his first term, and willing to embrace some near-term pain in exchange for what he views as the long-term gain as higher revenues from tariffs, more jobs on US soil and higher growth with, further down the road, perhaps the chance to cut income taxes as a result.

"Bessent seems equally determined, judging by his televised interview comments about the need for America's economy, and companies, to wean themselves off their addiction to government spending.

"Whatever investors think of them, it may pay to judge the efficacy of the White House's policies more through the prism of the US government bond, or Treasury, market than via the S&P 500, Dow Jones or NASDAQ Composite equity indices.

"Bessent appears concerned by four, interconnected, issues:

• Federal borrowing has continued to soar. At the end of 2024 it stood at a record $36.2 trillion, and the Congressional Budget Office's January estimates suggested that will grow by $22.1 trillion in the next 10 years.

Source: FRED - St. Louis Federal Reserve database, US Congressional Budget Office

• The interest bill has therefore shot up to an annualised rate of $1.1 trillion, or a fifth of America's taxation income. That is forcing the discussion about federal spending cuts and increasing revenue from tariffs (among other sources).

Source: FRED - St. Louis Federal Reserve database, US Congressional Budget Office

• The average interest rate on the US federal debt is 3.27%, but the benchmark two- and 10-year Treasuries yield 4.00% and 4.37% respectively, at the time of writing. Any new issuance is thus going to be more expensive, as is replacing and refinancing existing paper. The bad news here is the profile is very short, with half of the publicly-held US government debt due to mature in the next three years. The better news is that the debt held on an intragovernmental basis has a longer maturity profile so that the overall duration of US Federal debt is around six years - but this is still a long way lower than in the UK, where the average duration is some fourteen years, a figure which gives Chancellor Reeves some greater room for manoeuvre.

Source: Source: fiscaldata.treasury.gov. Based on publicly held debt only and excludes $7.3 trillion of intra-governmental holdings

• Even so, the need to refinance a big chunk of maturing debt in 2025, 2026 and 2027 may be why US 10-year Treasury yields are refusing to go down, even as the Federal Reserve cuts headline borrowing costs - bond vigilantes could be looking at the amount of paper coming their way from new paper to cover both fresh borrowing and refinanced debt.

Source: LSEG Refinitiv data, US Federal Reserve

"All of these numbers focus the mind and mean America must at least make a good show of tackling the national debt. Otherwise, the cost of borrowing could soar and mean the interest bills either become so crushing they hobble the economy, or the US has to print its way out of trouble so it can pay, with all of the inflationary implications that has, even for the globe's reserve currency.

"This is also at a time when the US economy is growing. An unexpected recession would hit tax income, increase welfare spending, and make things look even worse.

"A further danger is how the sort of austerity promised by the Department of Government Efficiency's spending cuts lead to the slowdown or recession that simply blow up the numbers, or at least force some more highly unorthodox policies. And that could just be why gold continues to march higher, seemingly in lockstep with the US deficit, as investors seek a bolt hole, just in case something really unusual develops."

Source: LSEG Refinitiv data, US Congressional Budget Office