Can you remember what caused Liz Truss's brief tenure as Prime Minster to collapse? It was because she crossed the line in the sand which defines the point at which investors stop buying government bonds. We all know that 'the line' exists, but nobody knows where it is until you cross it. Liz Truss went for investment in growth with tax cuts without considering when investors would stop buying gilts to finance the plan. The chaos ended her short stint as Prime Minister but immortalised her with the phrase “the Liz Truss moment.”
We were left with the conviction that adverse reactions from the equity and bond markets would always constrain politicians. So-called ‘bond vigilantes’ enforce discipline by selling bonds in response to reckless fiscal policies, so driving up yields and borrowing costs. It’s not just votes that drive democracy.
On April 2nd, 2025, the Trump administration announced sweeping "reciprocal" tariffs to address trade deficits designated as a national emergency. On April 5th, 2025, the US imposed reciprocal tariffs of at least 10% on imports from countries with significant trade deficits. Trump specifically targeted China on April 9th, 2025, with a 125% tariff, escalating the existing US-China trade war. Planned tariff increases for other countries were paused for 90 days when Trump was warned of a potential failure of the US Treasury Bond market. The US stock market, the US Dollar and the prices of longer-dated US Treasury Bonds started falling simultaneously. That was perhaps the day when Trump sensed a Liz Truss moment coming towards him. When equities fall, bonds are meant to go up, but both markets fell, showing investors selling risky equities found the government bond market unattractive, presumably doubting the ability of the US government to finance its spending with bond sales.
It is the bond market rather than the equity market which wields the ultimate power.
On April 10th, 2025, China responded by raising tariffs on American goods to 125%, up from the existing 84%. China stated that further US tariffs would be ignored as the Chinese market could no longer accept US imports at the current tariff levels.
This negative bond market sentiment flowed across to the Bank of England. On April 10th, falls in longer-dated gilts drove the Bank of England to drop plans to sell long-dated gilts, instead selling shorter maturity gilts.
Governments and corporate borrowers like issuing longer-dated bonds because it allows them to lock in debt finance without the worry of refinancing in a few years in a market that might have less appetite to lend them any money. The event central banks dread is a buyers’ strike for their bonds, likely causing severe economic stress. The Bank of England said it had made the decision in light of recent market volatility and that it intended to reschedule the long-maturity auction to the following quarter to reduce the bonds held in its asset purchase facility as evenly as possible across maturity sectors.
The conclusion of all this is clear – it is the bond market rather than the equity market which wields the ultimate power.
Trump’s behaviour gives us confidence that the hypothetical feedback loop of investors constraining the behaviour of politicians is still intact, showing a market-driven constraint on the damage politicians can inflict. This is how it’s meant to work, and it gives us confidence for the future.
