17 Jan 2025
The ongoing global government bond selloff has pushed 30-year gilt yields to their highest level since 1998, drawing comparisons to the fallout from the Truss government’s 2022 budget fiasco. Fidelity Strategic Bond portfolio manager Mike Riddell explores the key factors driving the sharp rise in bond yields and analyses the implications for UK fixed income markets.
Key points
The gilt selloff of the last few days has inevitably grabbed the headlines, where a common conclusion is to point fingers at the government. But this would miss the point; this is mainly a global fixed income story, not just something limited to the UK. Gilt yields are broadly moving with US Treasuries, where 30-year gilt yields have risen by no more than 30-year US Treasuries have done over the past couple of months. And there has been a similar sized move even in long dated German government bonds in the last month.
That’s not to say that the UK has been immune to pressure. Although there’s not any sign of a UK crisis yet, a worrying recent development 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 support the pound. 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.
Chart 1: 2yr and 30yr Gilt yields have risen sharply with curve steepening
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Chart 2: UK 30yr yields underperforming the US in recent days
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Source: Bloomberg, 09 January 2025.
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 premium or ‘term premium’ to compensate them for owning longer dated government bonds.
What does this mean for the UK?
The obvious implication of these moves is that it’s now become a lot more expensive for everyone to refinance their debt. If this selloff continues, it’s going to push deficits wider over the long term, 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 anyone who wants a fixed rate mortgage - a jump higher in the risk-free rate is a tightening of financial conditions, which will dent global economic growth. So, if sovereign borrowing costs continue to surge higher, then risk assets could start to come under substantial pressure.
However, positively for UK investors, 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%, representing an attractive return over the long term.
Important information
This information is for investment professionals only and should not be relied upon by private investors. The value of investments in overseas markets may be affected by changes in currency exchange rates. Investments in emerging markets can be more volatile than other more developed markets. The value of bonds is influenced by movements in interest rates and bond yields. If interest rates and so bond yields rise, bond prices tend to fall, and vice versa. The price of bonds with a longer lifetime until maturity is generally more sensitive to interest rate movements than those with a shorter lifetime to maturity. The risk of default is based on the issuers ability to make interest payments and to repay the loan at maturity. Default risk may therefore vary between government issuers as well as between different corporate issuers. Sub-investment grade bonds are considered riskier bonds. They have an increased risk of default which could affect both income and the capital value of funds investing in them. They can also use financial derivative instruments for investment purposes, which may expose the funds to a higher degree of risk and can cause investments to experience larger than average price fluctuations.