Bond Markets Have Europe’s Biggest Economies in a Bind. Why It’s a Warning for Trump.

U.K. finance minister Rachel Reeves and Prime Minister Keir Starmer are likely to shelve plans for unpopular tax hikes. The bond market won’t be happy. (Jacob King – WPA Pool / Getty Images)

The U.K. government has been struggling to plug a fiscal hole, shying away from both tax hikes and spending cuts.

Bond markets have the leaders of Europe’s biggest economies running scared.

The U.K. government is set to unveil its annual budget on Nov. 26. It’s aiming to build economic credibility and curb borrowing costs so it can ward off activist investors using the bond market to influence government policy. France and Germany are facing a similar challenge amid rising yields and mounting deficits. The U.S. isn’t immune from the pressure, either.

The bond vigilantes —to borrow a term economist Ed Yardeni used to describe the activist fixed-income investors who tried to rein in inflation in the 1980s—have European governments in a bind already.

In the U.K., lawmakers are still trying to banish the memory of Prime Minister Liz Truss’ ill-fated September 2022 mini-budget, which drove up gilt yields and sent the pound plummeting. In response to the crisis, a tabloid newspaper started livestreaming a video of an unrefrigerated head of lettuce to see if it could outlast Truss’ premiership. The leaf vegetable won when she stepped down after just 49 days in office.

Since winning power in a landslide last summer, Prime Minister Keir Starmer and his finance minister Rachel Reeves have made balancing the books a priority. The Office for Budget Responsibility, an independent watchdog that keeps an eye on economic policy and the public finances, has estimated a deficit of 137.3 billion pounds ($180.6 billion) for the fiscal year that ended in March, which equates to 4.8% of national income. Government debt is running at just over 100% of gross domestic product, up from just under 38% at the start of the 21st century, according to data from the International Monetary Fund.

Starmer and Reeves initially tried to plug the fiscal hole with cuts in social programs earlier this year, but an internal rebellion forced them to water down those plans. The government then laid the ground to raise the basic rate of income tax for the first time in 50 years, which would have broken a promise from its 2024 general election manifesto. But it now seems to have rowed back on that idea, too.

Voters aren’t happy. Starmer’s Labour Party has fallen more than 10 percentage points behind Reform U.K., a right-wing party formed in 2018, in some opinion polls. But there isn’t an obvious alternative to letting the market dictate fiscal policy. Truss tried to shake up the system with unfunded tax cuts, and look how that went.

“This is a center-left government, so they’re not willing to knife spending…The Truss episode has highlighted that the government doesn’t have the option to ignore the financial markets,” George Buckley, chief U.K. and euro area economist for the Japanese investment bank Nomura, tells Barron’s.

“Yields rising would only make the situation worse,” he adds, noting that a public-finance watchdog has forecast that a 1% rise in 10-year gilt yields would drive up the government’s annual interest payments by about £10 billion. Yields have climbed by nearly a quarter of a point since Starmer became Prime Minister in July 2024.

This isn’t just a problem for the U.K. It could be a growing issue across the Atlantic. President Donald Trump noted that the bond market reaction had been “very tricky” when he said he would scale back some tariffs in late April.

Trump’s signature tax bill, approved in July, is expected to add trillions of dollars to the deficit over the next decade. That risk is pushing up borrowing costs for both the government and ordinary Americans.

Elsewhere in Europe, three French governments have collapsed over the past 18 months due to budgetary disputes, with lawmakers failing to pass austerity measures that aim to reduce the deficit.

Government borrowing costs have been rising all the while. In September, the yield on the French 10-year government bond topped its Italian counterpart for the first time since 2008. That would have been unthinkable in the early 2010s, when several southern European countries struggled to pay their way, sparking a euro area debt crisis.

Germany is part of the trend, too. With Russia still at war in Ukraine and the White House wavering on how far it will go to help Kyiv, Chancellor Friedrich Merz has pledged to ramp up military spending. The country’s stability council said in October it expects the debt-to-GDP ratio to hit 80% in 2029, up from 62.5% last year. The ratio has only ever topped 80% once before, in 2010, according to the IMF.

European stocks are flying high despite all this, benefiting from investors looking to pivot away from the U.S. to shield their portfolios from tariff turbulence. London’s FTSE 100 and Frankfurt’s DAX have both jumped about 17% this year, meaning they’re outperforming the S&P 500 . Political instability has weighed on Paris’s CAC 40, but it’s still up 8.5% in 2025.

Investors can see that the centrist parties in power in Western Europe are trying to address the threat from the bond vigilante, even if that leaves them open to criticism from both the left and the right.

In the U.K., the government’s best option on Nov. 26 may be to rein in spending and put up tax. However, it now looks like it will do neither as Reeves avoids unpopular decisions to protect her political future.

The bond vigilantes won’t like that.

The market sees the finance minister as a “safe pair of hands,” but she could reassure investors by going further, says Buckley. “The larger the fiscal headroom that the chancellor chooses to build in, the more markets will be comfortable,” he adds.

While the budget is unlikely to bring about a repeat of Truss’ disastrous financial statement, traders in the U.K. and U.S. should still be wary.

The specter of the bond market—and the ghost of the lettuce—are still haunting European politics.

Write to George Glover at george.glover@dowjones.com