Blain’s Morning Porridge Jan 14^th 2025: Bond Bear Markets – Rock, Scissors, Bomb.

“When bond markets cough, financial plague often lurks around the corner.”

The bond bear market looks set to deepen as rising energy prices threaten to keep inflation sticky. The way bonds impact the economy is more complex than most understand – it’s not  just interest rates, but how inflation, and growth limit policy choices.

Yesterday a regular Morning Porridge Reader wrote to me and pleaded that I don’t write anything more about the UK and Government Bond markets. OK… but No!

Government bond markets matter. They are going to matter more as the global bond bear market deepens. Bond bear sentiment may overturn much of 2025’s cosy expectations about unlimited equity upside and the joys of ButtCoin. But, in deference to the request that I “STFU”; let me dwell less on febrile politics, and more on the brutal realities that await us due to the Govt Debt conundrum this morning…

The first point is the global economy is all about the cost of energy.

Energy is an increasingly scarce resource. Its cost is set to rise – dramatically. This is the time to be invested in new energy, data and cooling systems – these are the future. But Energy provision and grids are difficult and aren’t constructed overnight. (My own pet theory (based on “things are never as bad as we fear” thinking), is computing tech will evolve into less power/heat intensive systems faster than we think – in 10-years massive data-warehouse cooling systems may be the Betamaxes and iPods on the 2020s.)

Yesterday oil prices became the Sovereign Bond Markets’ next big, big worry. We may be on the verge of an outbreak of peace in the Middle East, but Brent hit a 6-month high yesterday. Oil price inflation will further drive rate higher – prices are rising as Russia’s Ghost fleet came under increased sanctions pressure. Trump may exacerbate energy tensions – the effects are more limited on the contained US economy. Geopolitics remains a very real destabiliser on energy costs.

Also yesterday, UK Premier Sir Keir Starmer announced a massive push into AI as the salvation for the UK economy  – which is going to be something of a challenge for an economy with the most expensive power in Europe, and an energy grid that came close to running flat last week. The amount of new power that will be required to AI the global economy (while some folk continue to mine Bitcoin!) is going to be a critical factor determining future growth. Some nations will succeed, but many will fail to provide enough secure power.

A second really interesting question yesterday was: Which nations will go bankrupt as a result of the current rise in Govt Bond rates? Really interesting one – what if I say; Not the ones you expect.

Despite the number of nations that do fail – usually because they borrow someone else’s currency which proves impossible to repay, and the rule that says whatever bankers say is wrong: like “nations don’t go bust”. However, Financial Sovereign Nations don’t go bust. Something much worse can happen – they tumble into stagnation and irrelevancy.

Financial Sovereign nations are those that own the money printing presses and have freely convertible currencies. If they find there isn’t enough dosh in the national piggy bank – because a recession has caused taxes to tumble perhaps, or they’re fighting a vicious costly war – then they have the option to simply print money. If they do it unwisely, that will potentially impact the economy in other ways: pushing up the yield of government bonds, but also impacting the value of the currency downwards as global investors loose confidence. It’s possible for global investors to lose faith in the bond market and currency, pushing up inflation (as the currency collapses) and rates (as they reject the nation’s bonds), triggering stagflation.

(European members of the EURO are not financial sovereign. They share a currency by committee. The core of that problem is best illustrated by asking what might German voters think if financially conservative Germany (63% debt to GDP) was asked to pay Italian (135%) and French (113%) pensions!)

Stagflation would be a bad outcome – which is why financial sovereign nations demonstrate great care to maintain their political credibility; that’s how the Virtuous Sovereign Trinity works: that a nation with a solid currency, a sustainable bond market and political competency will succeed.

Naturally, the world is more complex that that.

At present most Western Nations (with the interesting exception of Germany) have debt quantums in excess of 100% of GDP – meaning they owe the market more than the economy makes per annum. That’s not actually a problem as the maturity of their bonds are longer than a year, (in this respect the UK has the longest average bond maturity – about 15 years), and they can repay that debt from a portion of taxes over that time, spending the rest on government provided services.

So far so simple. However, every year Governments borrow more debt, meaning debt has become a permanent fixture of nations funding. Again, that is not necessarily a problem. As long as the economy is growing faster than the debt quantum and repayments are rising, then debt remains a steady or falling portion of the economy. As has been pointed out many times, healthy economies are those showing greatest growth. However, the financial size of an economy grows in two ways:

• The pace of increased goods and services – traditional growth
• The rate of inflation

The basic rule is that a financially sovereign nation’s debt remains manageable as long as the combined rate of the monetary growth of the economy – growth plus inflation – is more than the interest rate the govt is paying.

Debt has become a problem today because from 2009 – 2022, following the global financial crisis of 2008 (the collapse of Lehman Brothers), developed nations paid artificially low interest rates, triggering a host of consequences:

• Asset Price inflation in Bonds and Stocks
• Rising Income inequality as the value of financial assets and housing (generally held by the rich), soared due to artificially low interest rates
• Soaring debt quantums due to artificially low interest rates.

The costs of these are now coming due across Western economies.

• Inflation remains sticky around 3% – and could be set to spike higher if energy price shocks develop – a much higher probability potential than markets are prepared to acknowledge.
• Growth – with exception of the USA which remains resilient and robust – the global economy has slowed, largely as nations, corporates and individuals, all collectively realisied they were bust and solving that is a massive conundrum…

For nations like the UK the problem is real interest rates of 5% are higher than 3% inflation plus 1% growth. That means the scale of debt in the real economy is accelerating rather than being inflated away. The only answer is to cut debt. If we could get growth back up to 2% plus – that would help, but it means the economy has no surplus to spend on infrastructure, defence or services… which leads us back to how do you make AI work without a massive investment in energy provision?

For the UK to become an AI powerhouse, we need plentiful cheap energy. The Hinkley Point C Nuclear Power Station won’t be on-line for years (and may not ever be finished according to some rumours). Sizewell C won’t be on line till the 2030s. Till then the UK is hoping renewables will take the strain, but Dunkelflautte weather (no wind, no sunshine) leaves the nation’s energy security vulnerable. The investment could come from the private sector, but US corporates already own most large UK firms; why would they build AI in the UK to compete with US AI?

As inflation and rates look set to remain “sticky” for longer there are four alternatives for Government to look at in terms of sorting out the debt crisis at the heart of the economy:

• Growth – difficult. You can’t mandate growth. Economies needs the right conditions to thrive and nations like the UK, which have allowed national capital markets to wither and the productive capacity of the economy to be acquired by outside investors, are no longer aligned for intrinsic growth.
• Austerity – painful. Cut spending on welfare, services and infrastructure. The result will be to accelerate the collapse of the economy and relative poverty.
• Raise Taxes – political suicide. However, there has been very little serius discussion about taxation reform; transferring the burden of taxes on to the rich far more aggressively than currently. This will create enormous pushback – from the rich who don’t want to pay taxes. (They are quite happy if the poor folk pay for them…)
• Liability Management – Clever and Dangerous. What if we could magically improve the structure of national debt to make them more sustainable? It would require some clever and brave thinking, but is entirely doable. I have two particular ideas; Zonk Theory (which you can find by searching the Morning Porridge Data Base) and Maturity Extension which builds on what we learnt during QE.

Meanwhile, let me finish on two stories from the front pages this morning:

There is a story about a CEO hired at great expense last year by a UK services firm, Serco, deciding, apparently on a whim, to retire this year at 60, and getting a £2mm payout from his firm, described as “succession-planning” by the embarrassed chairman who hired him. Meanwhile, the same firm is in the press telling anyone listening how awful the rise in NI contributions and higher min wage have been, and that they are cutting hiring as a result. Corporates can cut executive pay, rewards and dividends to pay their share of taxes.

The Glen Sannox – the seven-year delayed and multiple-times over budget new Scottish Ferry finally set sail yesterday from the Mainland to Arran. What the BBC didn’t say is that its only doing 3 instead of 5 trips a day because despite all the delays it is too big for Ardrossan Harbour, so it can only do the longer Troon-Arran route. An example of classic British F*ck-uppery.

On that happy note… what will tomorrow bring… ?

Out of time, and off to do the day job…

Bill Blain

Author of the Morning Porridge

www.windshift.capital

billblain@morningporridge.com