It is never a good sign for finance ministers when bond market moves make the front pages of the non-financial press. That is what has happened this week in Britain as the rising yield on gilts (as British sovereign bonds are rather quaintly sometimes dubbed) rose to multi-year highs. The yield on ten year British government debt is now at its highest level since the 2008 crisis and above the levels of late 2022 which marked the brief Prime Ministerial term of Liz Truss, a near-financial crisis, and also the last time that the bond market managed to get itself onto the front page of the newspapers.
As one might imagine much of the coverage of this has been rather parochial and political in nature. Whilst there are certainly domestic British factors at play – notably an inflation environment which is looking more stubborn than once anticipated and much higher than once expected issuance following November’s budget – an awful lot of the move has been common to bond markets across the advanced economies.
At the time of writing, stronger than expected US payroll numbers have sent US Treasury yields heading northwards and gilt yields alongside them. Even the most close-minded of British writers would struggle to hold the Chancellor of the Exchequer responsible for developments in the American jobs market.
In an excellent piece this week the FT’s Alphaville Blog (registration required but free) took a deep dive into the recent moves in sovereign debt yields. Broadly put, both US and UK ten year yields have risen by just over a percentage point since their mid September lows.
The longer term chart is an excellent way of seeing, at glance, how developed market yeilds have typically moved together.
As Alphaville put it:
But we think it is worth unpicking a simpler nerdier question: what has happened to bonds over the past few months? Stepping back, most of the time the best answer to the question ‘why have gilts yields gone up/down?’ is ‘the Treasury market’.
While gilts don’t move basis-point-for-basis-point with Treasuries — and the possibility of divergence is ever-present — the 10yr gilt and 10yr Treasury have tended to drift together over the medium-term. Bunds too tended to move in lock-step with US government debt until the Eurozone crisis put a spanner in the works for European growth. Post-EU referendum, gilts traded in limbo for a few years, undecided as to whether to join Bunds in discounting economic stagnation, or Treasuries in discounting reflation. Following the Liz Truss mini-Budget shock of autumn 2022, they’ve moved back to trading pretty much in line with Treasuries.
Although, of which, is a rather long-winded way of making a simple but important point: what happens in the market for United States Treasuries matters perhaps just as much outside of the United States and inside it.
It has been a wild six months for the Treasury market and for wider global bond markets. During the summer, the yield plunged lower as financial markets in general became gripped by a growth scare. That helped nudge the Federal Reserve into delivering a bumper 50-basis point cut in September. Pretty much ever since that cut, yields have been grinding higher with the pace picking up in recent weeks.
the idea has been that a second term for Donald Trump would be great news for American equities, bad but not necessarily terrible for bonds, and positive for the dollar. The logic being that a combination of corporate tax cuts and deregulation will juice stock market returns whilst also sending the government’s deficit up and putting pressure on Treasury yields. Higher American yields should give the dollar a boost.
Implicit in the logic of the trade has been the idea that the rise in US yields would be enough to juice the dollar and send it higher but not enough to seriously hold back US economic growth or to cause equity market wobbles.
In recent days and weeks though, stocks have flatlined or fallen as yields have risen. The immediate reaction to the latest jobs market figures was a fall in equity futures and rise in Treasury yields.
The big question with which bond market investors and increasingly stock market investors in the USA (not to mention many in other economies) are grappling is ultimately, what does the incoming administrations policy-mix mean for inflation and the Federal Reserve?
In the most recent edition, carried out in mid-December, survey respondents scaled back their estimates of how far the Fed would cut in 2025.
The latest market pricing, which is sending yields higher, seems to be the broader bond market coming to much the same conclusion.
Higher rates seem here to stay.
