Bond yields rocket as inflation fears bite


Darren Bustin, Head of Derivatives

 28 October 2016

The US & UK have turned a corner:
“Bond yields rose sharply in almost every developed market yesterday as data surprises in the UK and US gather pace, pointing to a resilient global economy with expectations of future inflation. In the US, the likelihood of a Federal Reserve rate hike in December has led to rising Treasury yields, while in the UK, positive GDP data may have stalled further interest rate cuts from the Bank of England. 
“The long term prospect for rising interest rates may still be muted, particularly given the uncertainty around such factors as the UK leaving the European Union. This is compounded by institutional demand for long dated government debt, particularly in the UK, where price insensitive buyers remain.  The DMO issued £4bn of UK Gilts maturing in 2065, which were four times oversubscribed.
“For short term bond investors this may present a buying opportunity as yields, particularly in the UK, are back to pre Brexit levels. With Sterling falling further late in the day, inflation in the UK may continue to pose a future risk to long term holders of Gilts. 
Europe’s sell off intensifies:
“Meanwhile in Europe, noises around changes to quantitative easing have also meant that German and French long dated bond yields have rose the most, underperforming both in the UK and US. Thirty year German yields are up 0.12% today, however five year German bond yields now trade above the ECB’s deposit rate. This could remove the need for further significant changes to the quantitative easing programme, as more bonds become eligible to be bought by the ECB.     
“This is not the first time we have seen such a sell-off in Bunds. It should be noted that 10 year Bunds saw a similar sell off in April 2015, where yields rose 0.9% in the space of eight weeks. Approximately six months later yields had recovered back to the level seen before the sell-off.”

The US & UK have turned a corner
Bond yields rose sharply in almost every developed market yesterday as data surprises in the UK and US gather pace, pointing to a resilient global economy with expectations of future inflation. In the US, the likelihood of a US Federal Reserve rate hike in December has led to rising Treasury yields, while in the UK, positive GDP data may have stalled further interest rate cuts from the Bank of England. 

The long-term prospect for rising interest rates may still be muted, particularly given the uncertainty around such factors as the UK leaving the European Union. This is compounded by institutional demand for long-dated government debt, particularly in the UK, where price insensitive buyers remain. The DMO issued £4bn of UK Gilts maturing in 2065, which were four times oversubscribed.

For short-term bond investors this may present a buying opportunity as yields, particularly in the UK, are back to pre Brexit levels. With sterling falling further late in the day, inflation in the UK may continue to pose a future risk to long-term holders of Gilts. 

Europe’s sell-off intensifies
Meanwhile in Europe, noises around changes to quantitative easing have also meant that German and French long-dated bond yields have risen the most, underperforming both in the UK and US. Thirty year German yields are up 0.12% today, however five year German bond yields now trade above the European Central Bank’s (ECB) deposit rate. This could remove the need for further significant changes to the quantitative easing programme, as more bonds become eligible to be bought by the ECB.

This is not the first time we have seen such a sell-off in Bunds. It should be noted that 10 year Bunds saw a similar sell-off in April 2015, where yields rose 0.9% in the space of eight weeks. Approximately six months later yields had recovered back to the level seen before the sell off.

The value of investments and the income from them is not guaranteed and may go down as well as up and investors may not get back the amount originally invested. The views expressed are the author’s own and do not constitute investment advice.