Bond yields up, sterling down
In recent days, the UK has seen a slightly larger increase in bond yields at the same time as sterling has weakened. This is unusual because higher bond yields would normally attract more foreign capital and support the domestic currency. The recent sterling weakness implies a degree of caution from foreign investors, amidst growing concerns around the UK economy.
However, we feel it would be a mistake to read too much into short-term moves. Sterling has performed well over the past two years and even after the fall in the last week or so, is close to its post-Brexit highs.
A different situation to 2022
Whilst it may be tempting to look for parallels to the 2022 gilt crisis, following Liz Truss’s ‘mini budget’, this situation is not the same. One major difference is that defined-benefit pension fund liquidity has been sharply improved following the introduction of tighter regulatory requirements, so the impact of increased gilt yields should be contained. It is also worth noting that market volatility of this magnitude is by no means unusual, particularly at a time when liquidity can be low.
What does this mean for investors?
Most of the bond market moves are just tracking the US Treasury market, driven in part by a strengthening US economy. This tends to support corporate profitability, and paired with a strong dollar, is typically good news for equity investors.
More widely, whilst this move in gilt yields will undoubtedly cut into Rachel Reeves' already limited budgetary headroom, the likelihood of further tax rises in the coming months seems slim. Spending cuts are the more likely outcome, with the Treasury declaring recently that meeting the blunt fiscal rules remains ‘non-negotiable’. With public services already struggling, this will be politically challenging. Also, whilst gilt yields remain elevated, her goal of raising economic growth in the UK has also just become that bit harder.
