“Bond Vigilantes” Sound an Alarm on Fiscal Laxity
2022-09-30
■ The acceleration of interest rate increases globally since the FOMC has been accompanied by a widening of risk premiums in the UK and Italy.
■ Bond vigilantes are sounding the alarm about the new government's fiscal laxity, and Japan, which is planning economic measures, should also be on guard.
Since last week, interest rates have accelerated globally and asset prices have fallen sharply. The main reason for the rise in interest rates is that the U.S. Federal Open Market Committee (FOMC) raised its policy rate outlook sharply at its June 20 and 21 meetings, as the FOMC made clear its intention to continue to aggressively tighten money to control inflation, but in parts of the world, risk premiums have widened and spurred rates to rise.
The U.K. and Italy are the representative examples. In the UK, the tax cuts announced by the Truss government triggered warnings of increased issuance of state bonds as a source of finance, leading to higher long-term interest rates. The emergence of the "UK sell-off", combined with the fall in share prices and the pound, forced the Bank of England to buy government bonds to stabilize the market. In Italy, a right-wing coalition is expected to win a majority of seats in the upper and lower houses of parliament in the Jan. 25 general election, establishing a right-wing coalition government with far-right Italian Brethren (FDI) leader Leonardo Meloni as prime minister as the leading party.While Italy has received support for its opposition to the EU in refugee policy and other areas, it has received financial support through the European Reconstruction Fund (NGEU), which has raised concerns about policy management. Financial markets are increasingly wary of popular goading, with the difference (spread) between long-term Italian government bond yields and those of German bunds widening sharply since the end of last week and long-term interest rates reaching their highest levels since 2013.In July, the European Central Bank (ECB) introduced transmission protection measures (TPI) in an attempt to limit the widening of spreads on peripheral government bonds as a result of monetary tightening, while pushing interest rates up sharply to control inflation. However, on June 26th ECB President Lagarde has shown that she is negative about the TPI triggered by rising interest rates due to the policies of member states, including Italy. Italy may become a new flashpoint for the division of eurozone members.
As noted above, in the UK and Italy, "bond vigilantes "are sounding the alarm about the new governments' fiscal laxity. Unlike the massive fiscal stimulus allowed in the immediate aftermath of the new crown epidemic in 2020, the situation suggests that it is becoming increasingly difficult to undertake a push for fiscal easing in an economy with increasing upward pressure on prices due to tight supply and demand. Japan is scheduled to formulate comprehensive economic measures in October.One difference from the UK and Italy is that the Bank of Japan is controlling the rise in long-term interest rates, which is a matter of policy, but it should be noted that one side effect of fiscal easing in the face of growing pressure for a weaker yen is that it could raise the prospect of future inflation, prompting the wary to "sell Japan Yen" in the foreign exchange market and elsewhere.