Why The Bond Market Rules The World : Planet Money The world's biggest bond fund said it was pulling back on UK and US debt this week.
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Why The Bond Market Rules The World

James Carville, President Clinton's former top advisor, famously said: "I used to think if there was reincarnation, I wanted to come back as the President or the Pope or a .400 baseball hitter. But now I want to come back as the bond market. You can intimidate everyone."

It's a cruel lesson the United Kingdom, and to a lesser extent the U.S., is getting first-hand this week. On Tuesday, Newport Beach, Calif.-based Pacific Investment Management Co., which runs the world's biggest bond fund, announced it is cutting holdings of U.K. and U.S. debt as the two nations increase borrowing to record levels.

In a note on PIMCO's website, the bond giant warned that record levels of government bond issues in the US and UK and the end of looser monetary policies expected as early as late this year will put global financial markets under intense pressure.

As a result, PIMCO said it is moving more of its vast $940 billion under management into cash than at any time since the months before Lehman Brothers collapsed in 2008.

The move comes as the majority of strategists in the bond market are predicting prices for both US and UK government debt will fall this year.

Bondholders fear that a big rise in government bond yields, or interest rates, triggered by market concerns about public finances, could quickly feed through to higher mortgages and business borrowing costs. As yields rise bond prices fall, devaluing bondholders' holdings.

The development could have huge implications on Main Street. As interest rates rise, so does the cost of borrowing on everything from credit cards to mortgages. That could blunt any nascent economic recovery, reducing the governments' ability to pay off growing fiscal debts.

On a political level, to get back to Mr. Carville, PIMCO's move could have the most immediate effect on British Prime Minister Gordon Brown.

Brown is already facing serious threats to his tenure and any further erosion in the UK economy could add to his government's woes.

In an interview with Dow Jones Newswires this week, PIMCO's Scott Mather, head of global portfolio management, said the U.K. government faces an 80 percent chance of a credit-rating downgrade if its deficit reduction plans remain as they are.

Asked if the U.K. faced a serious risk of suffering a downgrade to its credit rating, Mather said "I think so."

"It's just a question of when on the current trajectory, not if," Mather said.

"Based on what we know today about the debt trajectory and about the inability to adjust that, I think it's greater than a 50% likelihood for sure. Call it more like 80%."

"Common sense would tell you that if you had a buyer in the market place which was taking the majority of the sector repeatedly... and then they disappeared, ...you would expect a reprising, and it could be quite significant," he said in a telephone interview.