Bond Traders Put Pressure on Debt-Laden Nations

Jason Alden/Bloomberg News
The central bank of Britain, a country attracting
the attention of investors seeking higher
interest rates on the nation's debt.

Gordon Brown, the British prime minister,
may not view the country's deficit as
a top priority, an analyst says.

Leon Neal/Agence France-Presse Getty Images


LONDON — The bond vigilantes are back.
But this time they are roaming mostly
through Europe rather than
the United States — at least for now.

Their mission: to force governments to cut
budget deficits that have ballooned
in the wake of the financial crisis.

As big investors in the credit markets,
activist bond traders developed
a fearsome reputation in the early 1990s
by pushing up yields on Treasuries
in order to force the government
to tame large deficits.

Their most famous target was
a newly elected president, Bill Clinton,
whom they pressured to
abandon campaign promises of tax cuts.

Today, the bond market posse has
set its sights on Europe — particularly
Britain and Greece — where stagnant
economies and high levels of
government spending have led
to the highest budget deficits in the region.

Although the left-leaning governments
in both countries are struggling
to show investors that they have
a workable plan to reduce
deficits — which now average around
13 percent of gross domestic
product — bond traders are
increasingly demanding higher
interest rates to reflect the rising risks.

Bond traders last week pushed
the spreads between Greek 10-year bonds
and their benchmark German
counterparts — a measure
of investor confidence in
the country — to highs of 250 basis points
after the nation's credit rating
was downgraded, raising concerns
over Greece's ability to service
its enormous debt.

In Britain, where the nation's economy
and finances have fallen so
sharply that investors fear a possible
downgrade of the country's triple-A rating,
bond traders are also taking
a hard line.

Last week, yields on gilts were
pushed to their highest levels
since the depths of the financial crisis,
after the Labour Party issued
a preliminary budget report
that skimped on details
of spending cuts.

"There is a clear drop in confidence
on the part of bond investors,"
said Mark Schofield, a fixed-income
strategist at Citigroup in London.
"I think it is all beginning to unravel."

The power of the bond trader to
influence governments once prompted
James Carville, Mr. Clinton's political
strategist at the time, to say that
he wished to be reincarnated
as one because "you can
intimidate everybody."

Mr. Clinton may not have been
intimidated, but he did heed
the advice of Robert Rubin, who joined
the administration from his post
at the top of Goldman Sachs,
that a policy of budgetary restraint
would keep the bond market happy
and interest rates on
United States government bonds low.

Since then, the vigilantes have been
largely in abeyance: As the global
economy boomed, public sector
deficits were not a concern for investors.

All that changed rapidly with
the onset of the credit crisis last year.
Bond traders surfed the global
liquidity wave, buying up government
debt all over the world in the view that,
just as most big banks were
too big to fail, so were
sovereign economies, no matter how
crushing their fiscal picture.

But Dubai World's recent decision
to delay payment on its debt has
brought the crisis to reality
for complacent bondholders.

They have begun to demand that
governments with large budget gaps
start to pay higher interest rates
on their bonds to reflect
rising sovereign risk — a development
that will lead to higher
borrowing costs in countries
like Britain, Greece, Ireland and Spain.

The United States and Japan also
face unusually high debt levels,
deepened by huge stimulus programs.

For the time being, investors are
still willing to lend to them
at generous rates.

But bondholders are running out
of patience as the finances of
even the wealthiest nations spiral downward.

As bond investors become
more impatient, some European
countries have taken
aggressive fiscal action.

In Ireland, the government this month
presented the most severe
budget in the nation's history,
largely to prove to wary bond investors
that it was serious
about cutting its own deficit.

"There is a greater market focus
now on who the fiscally vulnerable
countries are," said Michael Saunders,
the head of European
economics at Citigroup.

Britain falls into that category, he said,
because the British Labour government,
led by Prime Minister Gordon Brown,
is facing a difficult election battle
and appears more concerned
with pleasing voters than investors.

That could lead to a bond market
rout if gilt holders, a large proportion
of them foreign, come to the conclusion
that cutting the deficit is
not a top priority, he said.

In the euro zone, the European
Central Bank's interest in keeping
inflation low means that it is likely
to maintain a stable euro, leaving
smaller European economies with
no opportunity for a cheaper
currency to help
generate growth from exports.

As a result, governments in Portugal,
Ireland, Greece and Spain have had
to turn to increasingly skeptical bond
markets to raise funds while waiting
for their economies to recover
through the far more painful process
of squeezing wages
and shedding jobs
to restore competitiveness.

A recent report from
Standard Chartered even suggested
that weak euro members like Greece
and Ireland might reconsider
their ties to the union if investors
pulled the plug and stopped
refinancing their countries' debts.

"The idea that currency unions
can't break up is rubbish," said
Tim Congdon, an economist
and professed euro skeptic who
has advised Conservative
governments in Britain.

"The critical issue is whether
governments can repay their debts
in new currencies
or euros once they leave."

If they can pay back bond investors
in new and cheaper currencies,
then it is in the interests of countries
like Greece to go out
on their own, Mr. Congdon said.

But with other countries seeking
the shelter of the euro and leaders
like Angela Merkel of Germany hinting
that the big powers would come
to the rescue of Greece and other
distressed countries if necessary,
most economists argue that
the euro zone is unlikely to crack.

Still, that has not stopped
bond investors from talking up
a new divergence trade
in Europe — the flip side to
the convergence trade earlier
this decade, during which Irish,
Greek and Spanish government bonds
were bought on the theory that
a grand economic harmony
would sweep Europe.

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Sent from Kigali, Rwanda

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