Why the US bond market matters

Felix Martin's "Real Money" column.

On 22 May, Ben Bernanke, the chairman of the board of governors of the US Federal Reserve, made what must have seemed to innocent observers an innocuous remark: he suggested that the era of nearzero interest rates in the US could not last for too much longer and that the Fed might begin to wind down its policy of quantitative easing (QE) later this year.

The reaction of the world’s financial markets was swift and dramatic. First, the interest rate on US government bonds jumped. Then the world’s currency markets went haywire. The US stock market battled on for a few more weeks before it, too, took fright and embarked on a precipitous descent.

People who are not finance professionals might be forgiven for asking what all the fuss is about. Why, after all, should these inconsequential remarks matter so much – and so what if the interest rate on US government bonds rises by a mere 1 per cent? Is any of this relevant to normal people who don’t spend their time buried in the back pages of the Financial Times? The answer, unfortunately, is yes.

The government bond market is the axis on which the financial system of every modern, capitalist economy turns. The interest rate at which the government can borrow is the most important price in the economy – the one on the basis of which the price of every other financial asset and, indirectly, all other prices and wages are set.

Companies and individuals pay interest rates on their borrowing at rates set as a markup over the government’s rate. So if the UK government can borrow for a term of ten years at 2 per cent, then a financially robust and well-established company might be able to borrow at 3.5 per cent; and a flightier, less well-capitalised, more speculative one might be able to borrow at, say, 7 per cent. You or I, meanwhile, might be able to borrow at an even higher rate than that. When the interest rate the government pays moves, so do all the others. Thus, the interest rate on government bonds affects the entire economy.

In this matter, as in so many others, the US is more important than every other country. It is not just that the interest rate on US government bonds is the reference point for the largest economy in the world. The US dollar is also the world’s de facto reserve currency – it’s the only currency that almost anyone anywhere is ready to accept and so everybody wants to keep a precautionary store of it.

As a result, US interest rates filter through to the entire international economy as well. The US dollar is the primary currency of international finance – so that when the interest rate on US government bonds goes up, it becomes more costly not only for the US treasury to borrow at home but also for any government, company or individual almost anywhere in the world to borrow from abroad. Nor is that the end of the story. The differential between the interest rates on government bonds in different countries is a key determinant of exchange rates.

All other things being equal, if the interest rate on the US government’s bonds rises when the interest rate on the British government’s bonds remains unchanged, investors will try to rebalance their investments towards US bonds and away from British ones. As they do so, they will drive down the value of the pound sterling relative to the US dollar.

Even small changes in the interest rate on US government bonds can have a big effect on the relative value of currencies in this way – especially in the emerging markets. In the few weeks since Bernanke made his remarks, the currencies of Mexico, South Africa and Brazil, for example, have all lost more than a tenth of their value against the US dollar. This is extreme volatility of exchange rates and it can be highly disruptive of international trade and finance.

In short, the interest rate on American government bonds is the single most important regulating factor in the world economy. It’s no wonder that James Carville, Bill Clinton’s electoral strategist, reflected ruefully in 1993, “I used to think if there was reincarnation, I wanted to come back as the president or the pope . . . but now I want to come back as the bond market. You can intimidate everybody.”

So is it a good or a bad thing that US interest rates are on the rise following Bernanke’s recent pronouncements? It used to be easy to answer to that question. The link between the central bank policy or base rate and government bond yields was simple. When the economy was in rude health, the central bank would hike its policy rate and the interest rate on government bonds would rise; and when the economy was running out of steam, it would cut and bond yields would fall. Higher rates meant a healthier economy.

Since 2009, however, this transparent link between the bond market and the central bank has evaporated. With central bank policy rates stuck at zero, the bond market has had to take its cue not from monetary policy itself but from officials’ speeches and journalists’ scoops. The utterances of central bank officials such as Bernanke have become major economic data in their own right. The medium has become the message.

The result has been to turn investing in government bond markets into a kind of monetary Kremlinology, in which every passing comment of central bankers is minutely parsed for clues to the true direction of policy. In June, the new Kremlinologists concluded from Bernanke’s latest oracle that the global economy was in robust enough shape to tolerate a rise in the all-important interest rate on US government bonds.

For all our sakes, we had better hope that the divinations of the new Kremlinologists turn out to be more accurate than those of the old ones.

Traders work on the floor of the New York Stock Exchange. Photograph: Getty Images

Macroeconomist, bond trader and author of Money

This article first appeared in the 01 July 2013 issue of the New Statesman, Brazil erupts

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Keir Starmer: “I don’t think anybody should underestimate the risks of getting Brexit wrong”

The former director of public prosecutions is now heading up Labour’s response to Brexit. But can he succeed in holding the Tories’ feet to the fire?

Early in his new role as shadow Brexit secretary, Keir Starmer was accused of being a “second-rate lawyer”. The gibe, in a Commons debate, came from none other than Iain Duncan Smith. Starmer was director of public prosecutions for five years and later stood for parliament in 2015. No novice, then. Within a few days, Duncan Smith stood again in the House, this time to offer his apologies.

A fortnight later, I met Starmer at his quiet office in Westminster. He was sitting at a table piled with papers, in an office that, a discreet family photo aside, was unadorned. He had just got back from a whirlwind trip to Brussels, with many more such visits planned in the weeks ahead.

Starmer returned to the shadow cabinet after Jeremy Corbyn’s second leadership election victory last month. “The series of agreements we will have to reach in the next few years is probably the most important and complex we’ve had to reach since the Second World War,” he told me.

Starmer, who is 54, took his time entering politics. Born in 1962, he grew up in a Labour-supporting household in Surrey – his father was a toolmaker and his mother a nurse – and was named after Keir Hardie. After studying law at Leeds University, he practised as a human rights barrister and became a QC in 2002. In 2008, after varied legal work that included defending environmental campaigners in the McLibel case, he became the head of the Crown Prosecution Service for England and Wales as well as director of public prosecutions, positions he held until 2013.

When in 2015 Starmer ran for a seat in parliament to represent Holborn and St Pancras in London, it was assumed he would soon be putting his expertise to use in government. Instead, after Labour’s election defeat under Ed Miliband, he served as one of Corbyn’s junior shadow ministers, but resigned after the EU referendum in June.

Now, he is back on the opposition front bench and his forensic scrutiny of government policy is already unsettling the Conservatives. Philippe Sands, the law professor who worked with him on Croatia’s genocide lawsuit against Serbia, says he couldn’t think of anyone better to take on the Brexiteers in parliament. “It’s apparent that the government is rather scared of him,” Sands said. This is because Starmer is much more capable of teasing out the legal consequences of Brexit than the average Brexit-supporting Tory MP. Sands added: “It would be fun to watch if the stakes weren’t so very high.”

Starmer is a serious man and refused to be drawn on the character of his opponents. Instead, speaking slowly, as if weighing every word, he spelled out to me the damage they could cause. “The worst scenario is the government being unable to reach any meaningful agreement with the EU and [the UK] crashing out in March 2019 on no terms, with no transitional arrangement.” The result could be an economic downturn and job losses: “I don’t think anybody should underestimate the risks of getting this wrong.”

If Starmer seems pessimistic, it is because he believes time is short and progress has been slow. Since the referendum, disgruntled MPs have focused their attention on the final Brexit settlement. Yet if, as he argues, the starting position for our negotiations with the EU is wrong, the damage will have been done. MPs faced with a bad deal must either approve it or “risk the UK exiting the EU without a deal at all”.

It is this conviction that is driving his frantic schedule now. Starmer’s first month in the job is packed with meetings - with the representatives of the devolved nations, business leaders and his European counterparts.

He has also become a familiar face at the dispatch box. Having secured a commitment from David Davis, the minister for Brexit, that there will be transparent debate – “the words matter” – he is now demanding that plans to be published in January 2017 at the earliest, and that MPs will have a vote at this stage.

In his eyes, it will be hard for the Prime Minister, Theresa May, to resist, because devolved parliaments and the European parliament will almost certainly be having a say: “The idea there will be a vote in the devolved administrations but not in Westminster only needs to be stated to see it’s unacceptable.”

In Europe, Starmer said, the view is already that Britain is heading for the cliff edge. It was May’s pledge, that after Brexit the UK would not “return to the jurisdiction of the European Court of Justice”, which raised alarm. And among voters, there is “increasing anxiety” about the direction in which the UK is moving, he said. Even Tory voters are writing to him.

In the Labour Party, which is putting itself back together again after the summer’s failed coup, immigration remains the most vexed issue. Starmer told me that Labour had “earned a reputation for not listening” on the issue. Speaking on The Andrew Marr Show shortly after becoming shadow Brexit secretary, he said immigration was too high and ought to be reduced. But later that same day, Diane Abbott, a shadow cabinet colleague, contradicted him, publicly criticising immigration targets.

Starmer believes there is a bigger picture to consider when it comes to Britain’s Brexit negotiations. Take national security, where he warns that there are “significant risks” if communications break down between the UK and the EU. “Part of the negotiations must be ensuring we have the same level of co-operation on criminal justice, counterterrorism, data-sharing,” he said.

Crucially, in a Labour Party where many experienced politicians are backbench dissenters, he wants to reach out to MPs outside the shadow cabinet. “We have to work as Team Labour,” he stressed.

It’s a convincing rallying cry. But for some MPs, he represents more than that: a lone moderate in what can be seen as a far-left leadership cabal. Does he have any ambitions to lead Labour? “Having had two leadership elections in the space of 12 months, the last thing we need at the moment is discussion of the leadership of the Labour Party.” He has agreed to serve in the shadow cabinet, and is determined to stay there.

Starmer has found his purpose in opposition. “If we think things aren’t going right, we’ve got to call it out early and loudly. The worst situation is that we arrive at March 2019 with the wrong outcome. By then, it will be too late.”

Julia Rampen is the editor of The Staggers, The New Statesman's online rolling politics blog. She was previously deputy editor at Mirror Money Online and has worked as a financial journalist for several trade magazines. 

This article first appeared in the 27 October 2016 issue of the New Statesman, American Rage