UK welfare bill spooks the bond markets

The pound is falling as yields rise, suggesting fiscal stress

UK bond yields have taken a step higher as we progress through Wednesday, and Prime Minister’s questions has not eased concern that the bond vigilantes are circling. UK bonds are tanking today. As prices fall, yields rise, and the 10-year yield is up more than 10 bps, the 30-year yield is higher by 13 bps on Wednesday.

A new left-leaning chancellor is weighing on UK Gilts  

The sharp rise in bond yields happened during PMQs, the leader of the opposition asked the Prime Minister if he would confirm if Rachel Reeves would remain as Chancellor. The PM refused to say that the Chancellor would remain in position until the end of this parliament as a visibly distressed Reeves was watching on. The PM might be keeping his options open at this stage, but the Chancellor is a strange choice to axe from a market perspective.

The prospect of political turmoil is causing bond yields to rise. The market is pricing in the possibility of a replacement chancellor with a more left-leaning agenda, which is spooking the bond market and waking up the bond vigilantes from their slumber. 10-year yields are reversing their recent decline and are testing the 4.6% level. The 30-year yield is set to see its biggest one day increase since the 3^rd April, after President Trump’s announcement of reciprocal tariffs.

The pound falls, as fiscal risks rise

A worrying development is taking place: the pound is now the weakest currency in the G10 FX space, as the pound falls and yields rise. This is a sign of fiscal stress, which the UK has had to weather before. The FTSE 100 is less exposed to domestic policies; however, the FTSE 250 is down 0.8%. With all the main UK asset classes under stress today, the government needs to be careful about its next steps.

Will a surge in borrowing costs, even though the Bank of England is set to cut rates next month, cause another U-turn on benefit spending? Will there be cuts announced elsewhere, or will the government try and tap the taxpayer for more funds?

Interestingly, in the run up to the legislation around cutting the benefits bill, UK bond yields had been falling, suggesting that the bond market is receptive to highly indebted countries cutting spending. The reversal on these public sector spending cuts is having the opposite effect.

Is a new fiscal crisis brewing?

If yields continue to rise at this pace for the next few days, the PM and Chancellor will have to decide if they want to have a sensible fiscal policy whereby public sector debt is reigned in, or whether they want to please the Labour backbenches, who don’t seem worried by rising debt levels and forget that we are in a new era, where bond investors can shun sovereign debt in favour of less risky, less indebted corporate debt.

Overall, this could be the start of another fiscal crisis for the UK.