Gilt Corner: rates have been riding a rollercoaster


Craig Inches, Head of Short Rates and Cash

12 February 2018

If you’d happened to glance at UK government bonds at 2.30pm on Friday 2 February, and not checked again till 2.30pm a week later, you’d probably presume that nothing much had happened in markets.  On a one week basis, the level of bond yields were virtually unchanged. But between these two points, it was little short of a rollercoaster ride. 
 
The whipsaw momentum was influenced by events on both sides of the Atlantic. The steep fall in yields during the early part of the week was led by a flight to safety as equity markets plunged, following the first whiffs of stronger wage inflation in America. Gilts then sold off rapidly as the Bank of England dropped hints of an interest rate rise in May. Yields on 5 year gilts moved nearly 20 basis points before eventually closing close to where they’d been a week before. 
 
These moves would have been dramatic in their own right. However, given the placid conditions of markets during much of 2017 these effects looked particularly pronounced. The bond market’s own gauge of volatility, the Treasury Yield Volatility Index1 (TYVIX) highlights quite how benign conditions in markets had become, falling slowly towards historic lows over the course of 2017.  
 
As a result the TYVIX spiked last week, although unlike its equity counterpart this jump simply moved it back toward its long-term average, rather than the unprecedented moves in the VIX which burned the fingers of many investors who’d been shorting it.
 
With chaotic markets making national headlines and obscure financial market terminology a water cooler topic (the BBC’s  100 second explainer on the VIX is a particular highlight), it overshadowed the other trends affecting gilts this week. The shape of the curve flattened very slightly, and the yield on 30 year gilts touched 2%, before being pushed lower by the strong demand  from pension funds this triggered.  
 
In our funds we took part in the latest syndication but quickly took profits after the bond rose in value, as UK breakevens still look far too expensive in our eyes, based on the current profile for inflation. We also increased our cross market positions in US and Canadian bonds, while maintaining a slight short duration bias in our funds.

If you’d happened to glance at UK government bonds at 2.30pm on Friday 2 February, and not checked again till 2.30pm a week later, you’d probably presume that nothing much had happened in markets.  On a one week basis, the level of bond yields were virtually unchanged. But between these two points, it was little short of a rollercoaster ride.  

The whipsaw momentum was influenced by events on both sides of the Atlantic. The steep fall in yields during the early part of the week was led by a flight to safety as equity markets plunged, following the first whiffs of stronger wage inflation in America. Gilts then sold off rapidly as the Bank of England dropped hints of an interest rate rise in May. Yields on 5 year gilts moved nearly 20 basis points before eventually closing close to where they’d been a week before.  

These moves would have been dramatic in their own right. However, given the placid conditions of markets during much of 2017 these effects looked particularly pronounced. The bond market’s own gauge of volatility, the Treasury Yield Volatility Index1 (TYVIX) highlights quite how benign conditions in markets had become, falling slowly towards historic lows over the course of 2017.   

As a result the TYVIX spiked last week, although unlike its equity counterpart this jump simply moved it back toward its long-term average, rather than the unprecedented moves in the VIX which burned the fingers of many investors who’d been shorting it. 

With chaotic markets making national headlines and obscure financial market terminology a water cooler topic (the BBC’s  100 second explainer on the VIX is a particular highlight), it overshadowed the other trends affecting gilts this week. The shape of the curve flattened very slightly, and the yield on 30 year gilts touched 2%, before being pushed lower by the strong demand  from pension funds this triggered.   

In our funds we took part in the latest syndication but quickly took profits after the bond rose in value, as UK breakevens still look far too expensive in our eyes, based on the current profile for inflation. We also increased our cross market positions in US and Canadian bonds, while maintaining a slight short duration bias in our funds.

Chart 1: Treasury Yield Volatility Index (TYVIX) since January 2017

Source: Bloomberg

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. RLAM is not responsible for content on third party websites.