We love bonds, but we hate it when they make the front page. Let's face it, while they are psychologically interesting, there are no good stories about bond markets. It's always “no one's appointment”, “someone is breaking the economy”, or some such evil.
Readers would find it hard to miss the excellent coverage that bond products have produced over the past few months. Or really front page news that gilts are made beyond the in the last 24 hours.
There is an excellent explanation of what the current malaise means for the government – and the UK population in general – in MainFT.
But we think it's worth picking a simple nerdy question: what happened to bonds in the last few months?
going back, most of the time the best answer to the question 'why have gilts yields gone up/down?' it is the 'Treasury market'.
While gilts don't move basis-for-basis-point with Treasuries — and the potential for divergence remains — the 10yr gilt and 10yr Treasury tend to drift together over the medium term. Bunds also tend to move in lock step with US government debt until the Eurozone situation puts a damper on European growth activities.
Post-EU referendum, gilts sold in limbo for a few years, not sure whether to join the Bunds in reducing recession, or Treasuries in reducing reflation. Following the surprise Liz Truss mini-Budget for Autumn 2022, they have returned to trading heavily in line with the Treasury.
The global increase in yields since mid-September may not appear on such a long-term chart. But marketing is nevertheless interesting and important. First, because of the nature of the sale. Second, because of the impact it has on other markets, and government money.
'Type of marketing'? Does FTAV get 'thoughts'? Is there anything you can say other than “Line up, the monkey is sad“?
Yes, actually.
The latest low point in gilt and US Treasury yields was 16th September 2024 – two days before the Federal Reserve cut rates by 0.5 percent to 4.75-5.0 percent, and three days before the Bank of England. prices are kept constant by 5 percent. Both the Fed and the BOE since then cut prices by 0.25 percent (November 7).
Since that yield low, the ten-year Treasury yield has increased by 1.08 percent and the ten-year gilt yield has increased by 1.02 percent – to 4.7 percent and 4.8 percent respectively, increasing the annual cost of any new debt issued. , and pushing up the value of existing bonds.
We know that bond yields, and changes in them, can be cut and put into long-term inflation (so-called inflation rates) and real yields (promised money after accounting for inflation). How much is the increase in yield due to the increase in expected price? Others. But mostly the increase in bond yields is due to the increase in real yields.
There is no shortage of theories as to why inflation-linked bond yields should trade where they do, although there are no hypotheses we have yet encountered. Claim almost it is considered a commodity r-star financial markets – the market's estimate of the actual medium-term balance of the economy as a whole. Although some people think that the star is a load of balloons.
Real yields on gilts have tended to be lower than those on US Treasuries over the past decade. Going by all the r-star marketable theory, you could be forgiven for thinking that this gap reflected market expectations for lower economic growth. And, of course, who knows? But a common belief among UK investors is that inflation-linked gilt yields are lower than you might otherwise expect because UK private sector defined benefit pension schemes tend to have debt linked to inflation – and the extent to which buyers want to hedge the risk of softening linker yields to lower . levels.
Here's how real yields have evolved over the past few years:
With bond yields that translate into expectations of average central bank policy rates over a given period, real yields squeezed lower by pension demand will have a higher rate of inflation. And this is one definition of enforcement of authority The level of inflation has been normal for the UK market for most of the last fifteen years.
Today the rate of inflation that would equate to a ten-year return on UK inflation plus a normal ten-year inflation rate (not adjusted for inflation) is around 3.6 per cent per annum. This is a lot of inflation. But it is not significantly different from the 3.3 percent annual break-even rate of inflation and inflation that has averaged over the past ten years.
Break rates and actual yields are not the only way we can break and change dice yields. As we learned in boot camp bondyields are also the market's expectation of changes in overnight interest rates (the policy rate the market expects) and asset swaps (the amount governments must pay to rent bonds to the private sector, aka term premia).
Much of the rise in 10-year bond yields in recent months has been attributed to the market pricing in the central bank's policy stance over the next decade. And this cool chart made with data provided by Christian Mueller-Glissmann from Goldman Sachs shows the degree to which bond yields have fluctuated around expectations in the very short term of Fed rate action. In September the market's choice is worth a sixty percent chance of eight cuts or more in the next twelve months. It is now worth 30 percent for one or more turns to rise per year.
But on this side of the pond, gilt yields rose slightly more than expected by the Bank of England going it alone. Lawrence Mutkin, head of EMEA equities strategy at BMO, points to this quarter's premium as something that will become a big factor in bond markets around the world. As he puts it:
when Term Premia goes up for the government, so does Term Premia for everyone. This looks like “congestion”.
How can central banks respond to an era of rising premia? Maybe by cutting prices? If so, this – argues Mutkin – is effective financial management. 😬
How does the word premia develop? It is not healthy. While gilts have fallen against the exchange rate significantly in recent months, this takes them to the levels already found by US Treasuries against their exchange rate curve. Is this the result of QT / excessive government emissions? Answers in the comments please.
We now realize that we have missed a large number of charts for you. And even though that's not what's being done, we don't really see why we shouldn't pull out these different bits and pieces and dicing in a complete summary graphic to show not only what happened to ten-year bond yields, but more. again.
So while the answer to the question “how much have bond yields risen since mid-September?” “close to one percent of bonds with anything from five to thirty years remaining before maturity in the Treasury and gilt market alike”, the reason for the move varies:
In both markets, the simple reason why bond yields are higher is that the markets expect the Federal Reserve and the Bank of England to have higher interest rates not just next year, but over the next five, ten, and thirty years than they have been doing. in mid-September.
At the same time, bond market measures of inflation expectations and inflation did not jump, but this may be because the markets expect the Federal Reserve and the Bank of England to have higher interest rates than those that were established in mid-September.
In the UK there is a reduction in gilts against swaps, with ten-year gilts premia rising rapidly to levels seen in the US Treasury market.
None of this helps you understand the intraday movements in the bond markets that happened yesterday – they are interpreted differently as stupidity from investment banks in controlling the rate of locking, to the results of the five-year auction, to bond vigilantes in testing the Chancellor's mettle. But we hope it provides useful content.
Further reading:
– Sterling sales will continue until behavior improves
– Everything you always wanted to know about bonds (but were afraid to ask)