Introduction: Bond market slide deepens after strong US data

Good morning, and welcome to our rolling coverage of business, the financial markets and the world economy.

Trouble is brewing in the bond markets again, as investors grow more concerned about inflation, and signs that the US economy may be running too hot.

Government borrowing costs jumped yesterday, and are rising again in Asia-Pacific markets this morning, a move that is pulling down share prices.

Yesterday’s trigger was a surprisingly strong survey of US businesses – as we covered yesterday – showing that activity was rising at the fastest pace in five years, amid a surge in costs.

This prompted a sell-off in US government bonds, as traders calculated that this might prompt further rises in US interest rates to cool inflation.

Chris Weston, head of research at brokerage Pepperstone, says:

double quotation markWith unemployment at 4.1% and growth running above trend, the US economy is showing signs of modest overheating. The Federal Reserve will therefore be firmly on notice.

If the next inflation readings continue to print hot, policymakers may conclude that aggregate demand needs to be brought lower through the blunt tool of higher interest rates.

Investors were also alarmed by a surprisingly weak auction of US five-year bonds last night, which attracted low demand – perhaps a sign that appetite for Treasury bonds is waning…

Cue the sell-off! With bond prices sliding, the yield (or rate of return) on five-year US Treasuries was driven over 5% for the first time since 2007. 10-year US Treasury yields surged over 5%, in their biggest one-day move since Donald Trump’s ‘Liberation Day’ tariff announcement almost 18 months ago.

These moves are rattling the wider global bond market (as US debt is the ‘risk-free’ asset used as a benchmark by global financial markets).

Already today, yields on Japan’s benchmark bonds have hit their highest level in decades.

Ipek Ozkardeskaya, senior analyst at Swissquote, explains why markets were rattled:

double quotation markIn the US, flash PMI figures for September showed activity expanding at the fastest pace in more than five years. New orders grew at the fastest pace since April 2022, while manufacturing hiring was the strongest since February 2021.

Massive AI investment and resilient consumer spending outweighed energy-price-led worries, though supplier delivery times stretched, according to the same data, while input costs remained elevated due to high energy prices and supply-chain pressures.

In other words, economic activity expanded strongly while price pressures remained elevated. That’s the perfect combination for fuelling further rate-hike expectations.

The agenda

  • 11am BST: CBI distributive trades survey of UK retailers

  • 8.30am BST: Swiss National Bank’s interest rate decision

  • 1.30pm BST: US jobless claims data

  • 3pm BST: Bank of England’s Clare Lombardelli speech on “Macroeconomic Policy in a Heterogeneous and Imperfectly Rational World”

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Key events

UK ‘open to smaller fiscal headroom’ to reduce need for budget tax hikes

UK government debt was caught up in yesterday’s bond sell-off too, with the yield on 10-year gilts jumping 1.8% towards its highest level since the 2007 financial crisis.

Rising gilt yields will eat into the government’s ‘headroom’ to keep within its fiscal rules, as they show the cost of servicing the national debt, and issuing new bonds, has risen.

Rachel Reeves left her successor, John Healey, a buffer of over £23bn to be keeping within the fiscal rules (to have day-to-day spending covered by tax receipts, and for the debt to be falling as a share of the economy).

With government spending running above forecast so far this year, many City economists have already predicted that this headroom has shrunk.

And the Financial Times is reporting this morning that the UK government might accept a smaller fiscal buffer, rather than raise taxes to reinforce the headroom.

They say:

double quotation markGovernment figures are preparing to argue that maintaining March’s buffer is unnecessary at a time when borrowing and energy costs have risen sharply.

One person involved in the government’s discussions has suggested that headroom of £15bn would be sufficient, while another suggested closer to £20bn, and a third said no figure was yet being targeted.

Another senior government figure said there was “no magic figure” to demonstrate credibility to the market, arguing that Britain’s plan for rapid deficit reduction was potentially more important to borrowers.

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