The UK Treasury is this morning staring at the data screens with a familiar sense of dread. US inflation has spiked again, and markets are in turmoil. If you think this is just America’s problem, think again. The bond market is a global web, and the spider at the centre is the Federal Reserve. But the real wildcard is the man in the White House who, by all accounts, ‘loves’ higher prices. For a market obsessives like me, this is a nightmare scenario unfolding in slow motion.
Yesterday’s CPI print from the Bureau of Labour Statistics came in at a blistering 4.2% year-on-year, well above the 3.6% consensus. Core inflation, stripping out food and energy, hit 3.1%. These numbers are not transitory. They are the result of the Biden administration’s fiscal incontinence, combined with supply chain bottlenecks that show no sign of easing. But the real story, the one that will keep the Chancellor of the Exchequer awake at night, is the reaction of the bond vigilantes.
US 10-year yields spiked 15 basis points to 3.45%, their highest since 2007. The dollar surged. And then came the tweet. President Trump, never one to miss an opportunity, declared that inflation is ‘beautiful’ and that rising prices are a sign of a ‘booming economy’. He urged the Fed to keep interest rates low, effectively endorsing the very inflation that is destroying purchasing power. Markets took this as a signal that the administration will not stand in the way of price rises, and the sell-off accelerated.
For the UK, this is a triple blow. First, higher US yields suck capital out of London. The pound has already fallen 2% against the dollar this week, a move that will feed into import prices and push UK inflation higher. Second, the Bank of England is now in a bind. If it raises rates to defend the pound and curb inflation, it risks choking off the recovery. If it does nothing, inflation expectations become unanchored. And third, the UK’s own fiscal position is precarious. With gilt yields rising in sympathy with Treasuries, the cost of servicing our massive debt is ballooning. The Office for Budget Responsibility had assumed gilt yields of around 2.5% in its March forecast. They are now at 3.2% and rising. That is a multi-billion pound hole in the public finances.
The Treasury is now running the numbers. Every 1% rise in gilt yields adds roughly £25bn to annual debt interest payments. That is money that could have been spent on hospitals, schools, or tax cuts. Instead, it will go to bondholders. The Chancellor’s so-called ‘fiscal headroom’ is evaporating before our eyes. And with an election looming, the pressure to spend more is immense. The market will not be kind.
Let’s not forget the currency angle. A weaker pound is not all bad. It helps exporters and boosts the FTSE 100, which earns most of its profits abroad. But for the average Briton, it means higher prices at the petrol pump and in the supermarket. The Bank of England’s own survey shows that inflation expectations for the year ahead have jumped to 4.5%. Once those expectations become embedded, they are hell to dislodge. We are in a wage-price spiral, and the central bank is behind the curve.
Meanwhile, the rest of the world is watching. European bond yields are also rising, and the ECB is now under pressure to taper its asset purchases. The Japanese yen, the traditional safe haven, is weakening as investors flock to the dollar. This is a global repricing of risk, and the UK is caught in the crossfire.
The bottom line is this: Trump’s love of inflation is a dangerous game. He thinks rising prices are a sign of success. In fact, they are a tax on the working class and a threat to financial stability. The Treasury is right to be monitoring this situation closely. But monitoring is not enough. The Chancellor must present a credible plan to reduce deficits, or the bond market will do it for him. And that will be painful.
I have seen this movie before. It was called the 1970s. It did not end well.
