Traders expect further problems for the UK bond market

Featured Sponsor

Store	Link	Sample Product
UK Artful Impressions	Premiere Etsy Store

Investors expect UK gilt yields could return to levels seen at the height of last year’s “mini” budget crisis, after inflation data forced markets to revise their interest rate forecasts.

The two-year gilt yield, which is very sensitive to interest rate changes, hit 4.4% on Wednesday after inflation stronger than expected.

Moves on yields marked a sharp rise from 3.7% earlier this month, leaving yields heading for a peak of 4.7% last September in the wake of then-Chancellor Kwasi Kwarteng’s disastrous ‘mini’ budget , which contained £45bn of unfunded tax cuts. Wednesday’s moves also bolstered the UK’s position as the worst-performing major global bond market so far this year.

This time traders re-priced bonds and swaps after weeks of strong rally inflation and employment data, exacerbating concerns that the Bank of England will need to raise rates further to keep inflation in check. Yields rise when bond prices fall.

Paul Brain, global bond fund manager at Newton Investment Management, said he had been looking to buy gilts but the sharp rise in core inflation had given him “a bit of pause for thought”.

“The market is reevaluating what the Bank of England is going to do,” Brain said. “We are hesitant because it takes a while for the shock to transform into the market view.”

Swap markets are pricing in another three or possibly four interest rate hikes to a peak of 5.4% by December, a sharp rise from the expected peak of 4.8% late last week.

“I think there is further underperformance [of UK bonds] to come,” said Imogen Bachra, head of UK rates at NatWest, who now thinks the BoE will raise interest rates to 5% by the end of the year, having not expected further hikes before April’s inflation data .

“We could be talking about a peak above 4.5% for 10-year gilts and close to that for 2-year bonds as well,” he said.

Investors are particularly concerned about rising core inflation, which excludes volatile food and energy prices, which rose to 6.8% in April from 6.2% the previous month.

BoE Governor Andrew Bailey admitted on Tuesday that there were “very great lessons to learn” in setting monetary policy after the central bank failed to predict the recent rise and persistence of inflation.

While bond prices rallied last autumn after the BoE stepped in to buy £19bn of gilts on financial stability concerns, the yield on UK 10-year debt rose from 3% in February to 4.2 % today, and is approaching the “mini Budget Peak” of 4.5 percent.

Quentin Fitzsimmons, senior portfolio manager at US asset manager T Rowe Price, said he expects rising UK yields after last year’s “mini” budget to act as a “magnet” for bond prices.

“The gilt market is raising a yellow flag – if not a red flag – towards the Kwasi Kwarteng-[Liz] The pylon disaster and I don’t see what’s going to stop it, short of a very substantial recession,” he said.

UK bonds have outperformed other major bond markets this year, which is evident in the widening “spread” – or yield difference – between the US and Europe, an indicator that investors are demanding a premium. for UK bonds.

But some investors saw the sell-off as a buying opportunity. “We have implemented long duration in our gilt funds for the first time in five years,” said Craig Inches, head of rates and liquidity at Royal London Asset Management.