Hawkish BoE sends gilt yields rocketing


Craig Inches, Head of Short Rates and Cash

14 September 2017

The Bank of England’s latest decision on interest rates arrived totally in line with market expectations, with just two dissenting hawks and no changes on quantitative easing. Despite this, the Bank unsettled markets, as their hawkish comments seemed to be paving the way for a November rate rise, assuming economic data does not disappoint.
The suggestions that interest rates could rise much sooner than the market had expected was the final straw in a week that has seen yields rise over 20 basis points. Strong inflation data and low unemployment figures started the rout earlier in the week and left bond doves running for the exit. The sell-off on Thursday was particularly pronounced among shorter dated gilts, more sensitive to forthcoming changes in interest rates, where two year yields hit a new high for this year and rocketed ever closer to pre-referendum levels. 
In our view, although the die is not quite cast on raising rates just yet, any policy decisions which move government bond yields back towards more normal levels are a welcome return towards bond markets which look more connected to economic fundamentals. 
Royal London Asset Management’s fixed income team share three other key trends they see shaping bond markets this week:
1.     Austria does something surprising
The biggest surprise in government bond markets this week came from Austria, which printed a bond maturing in 100 years’ time, with a yield of just 2.112%.  While the duration is remarkable (the Austro-Hungarian Empire collapsed just 99 years ago, meaning by the time the principal is repaid the bond will have been around for over half the lifetime of any Austrian republic), more surprising was the quantity of debt which was printed. While the market expected around half a billion euros, with over €3.5 billion printed, this new supply has weighed on the long end of European government bond curves.
2.   Bonds from a Church and a Golden Nugget
Investment grade and high yield credit bonds have continued to look buoyant during the past week; while the insurance sector in Europe took a temporary buffeting from Hurricane Irma, the bonds have now recovered. In the primary market, a healthy pipeline of new issuance continues to flow, from an unusual Church of England bond with inflation linking built into just the coupon, to Golden Nugget (the US hotel and casino chain) who are rolling out a range of different bond and loans structures. 
3.   Refinance now, save later
One of the most striking trends of the early part of September has been the number of short dated corporate bonds which companies are now looking to refinance. With credit spreads at remarkably low levels, many larger corporate issuers are calling in their bonds maturing within the next couple of years, often in order to extend the duration of their borrowing.

The Bank of England’s latest decision on interest rates arrived totally in line with market expectations, with just two dissenting hawks and no changes on quantitative easing. Despite this, the Bank unsettled markets, as their hawkish comments seemed to be paving the way for a November rate rise, assuming economic data does not disappoint.

The suggestions that interest rates could rise much sooner than the market had expected was the final straw in a week that has seen yields rise over 20 basis points. Strong inflation data and low unemployment figures started the rout earlier in the week and left bond doves running for the exit. The sell-off on Thursday was particularly pronounced among shorter dated gilts, more sensitive to forthcoming changes in interest rates, where two year yields hit a new high for this year and rocketed ever closer to pre-referendum levels. 

In our view, although the die is not quite cast on raising rates just yet, any policy decisions which move government bond yields back towards more normal levels are a welcome return towards bond markets which look more connected to economic fundamentals. 

Royal London Asset Management’s fixed income team share three other key trends they see shaping bond markets this week:

1.     Austria does something surprising

The biggest surprise in government bond markets this week came from Austria, which printed a bond maturing in 100 years’ time, with a yield of just 2.112%.  While the duration is remarkable (the Austro-Hungarian Empire collapsed just 99 years ago, meaning by the time the principal is repaid the bond will have been around for over half the lifetime of any Austrian republic), more surprising was the quantity of debt which was printed. While the market expected around half a billion euros, with over €3.5 billion printed, this new supply has weighed on the long end of European government bond curves.

2.   Bonds from a Church and a Golden Nugget

Investment grade and high yield credit bonds have continued to look buoyant during the past week; while the insurance sector in Europe took a temporary buffeting from Hurricane Irma, the bonds have now recovered. In the primary market, a healthy pipeline of new issuance continues to flow, from an unusual Church of England bond with inflation linking built into just the coupon, to Golden Nugget (the US hotel and casino chain) who are rolling out a range of different bond and loans structures. 

3.   Refinance now, save later

One of the most striking trends of the early part of September has been the number of short dated corporate bonds which companies are now looking to refinance. With credit spreads at remarkably low levels, many larger corporate issuers are calling in their bonds maturing within the next couple of years, often in order to extend the duration of their borrowing.

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.