The interest rate on 30-year gilts hit its highest level in over 25 years yesterday (8 January), rising as high as 5.37%.
Meanwhile, the 10-year gilt has risen to its highest level since the great financial crisis.
The spike has led to concerns over the state of public finances, particularly following chancellor Rachel Reeves’s tax-raising Budget at the end of October. However, Laith Khalaf, head of investment analysis at AJ Bell, says that placing the blame solely on the chancellor is “probably wide of the mark”.
“Reeves’ maiden Budget was marginally inflationary, and did increase overall government borrowing, but since the beginning of October the US and UK 10-year bond yields have tracked upwards almost hand in hand.
“Those who think the current bout of bond market jitters is down to policies announced in the Budget need to explain why there has been such correlation in the upward march of bond yields both here and in the US.”
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Fidelity International portfolio manager Mike Riddell agrees that the upward trend is mainly a global fixed income story.
UK gilt yields have moved broadly in line with US Treasuries over the last few months, while Riddell also points out that there has been a similar sized move in long dated German government bonds in the last month.
“That’s not to say that the UK has been immune to pressure,” he says. “Although there’s not any sign of a UK crisis yet, a worrying development in recent days is that gilt yields have risen a little more than in other markets, at a time when sterling has sharply weakened.
“Normally currencies are driven by interest rate differentials, where higher gilt yields relative to other countries would be expected to push the pound stronger. The combination of a weaker pound and higher relative gilt yields has eerie echoes of August-September 2022, and if this continues, could potentially be evidence of a buyer’s strike or capital flight.
“What’s been interesting about the global bond market moves of the past few weeks is that this is an unusual ‘bear steepening’ move, where longer dated bond yields have risen by more than short-dated yields. These moves are indicative of fixed income investors becoming increasingly concerned about fiscal largesse, and all the government bond supply that accompanies it.
“It’s not about inflation concerns, where the market’s medium term inflation expectations are little changed since the beginning of November. Investors are instead demanding a higher risk premia or ‘term premia’ to compensate them for owning longer dated government bonds.”
Buying opportunity?
Among the implications of the gilt yield moves, refinancing debt has become more expensive.
“If this selloff continues,” Riddell adds, “it’s going to push deficits wider over the long, which then risks a doom loop since deficits need to be funded by ever more sovereign issuance.
“But it’s also bad news for corporate issuers, or for example anyone who wants a fixed rate mortgage – a jump higher in the risk-free rate is a tightening in financial conditions, which will dent global economic growth. So if sovereign borrowing costs continue to surge higher, then risk assets such could start to come under substantial pressure.
“But the positive news it that the potential return from owning government bonds has just got a lot higher too. If you buy a 30-year UK government bond today and hold to maturity, then assuming no default of course, the total return over the life of the bond is almost 400%.”
Richard Carter, head of fixed interest at Quilter Cheviot, says that gilt yields present an attractive opportunity for long-term investors.
“Despite this turbulence, gilt yields still present an attractive opportunity for long-term investors. Currently, they are well above expected inflation levels, making them a viable option for those looking to secure returns in a sluggish economy that might prompt further rate cuts by the Bank of England.
“For investors with a lower risk appetite, short-dated gilts still offer a promising avenue and are less sensitive to market fluctuations.”