We love the ties, but we hated them when they made the front page. Let’s face it, while they are intellectually entertaining, there are no good news stories about the bond markets. It’s always “someone failed”, “someone crashed the economy”, or something else as dire.

Readers would have been hard-pressed to miss the excellent coverage generated by rising bond yields over the past few months. Or indeed the front page news that gilts were created over the past 24 hours.

There is an excellent explanation of what the current malaise means for the government – and for UK citizens in general – in MainFT.

But we think it’s worth removing a simpler, nerdier question: what happened to bonds in the last few months?

retreat, FOR the most part the best answer to the question ‘why have gilt yields gone up/down?’ is ‘the Treasury market’.

While gilts do not move basis-point-for-basis-point with Treasuries – and the possibility of divergence is always there – the 10yr gilt and 10yr Treasury are likely to drift together in the medium-term. Bunds are also likely to move in lock-step with US government debt until the Eurozone crisis puts a spanner in the works for European growth.

After the EU referendum, gilts were sold in limbo for several years, unable to decide whether to join Bunds to discount economic stagnation, or Treasuries to discount reflation. After the Liz Truss mini-Budget shock in autumn 2022, they returned to trading more in line with Treasuries.

The global rise in yields since mid-September may look unremarkable on such a long-term chart. But sales are nevertheless both interesting and important. First, because of the nature of the sale. Second, because of its implications for other markets, as well as government finance.

‘Nature of the sell-off’? Did FTAV get ‘ideas‘? Is there really more to say than “Line go up, sad monkey“?

Yes, actually.

The recent low point in gilt and US Treasury yields was on September 16, 2024 – two days before the Federal Reserve cut rates by 0.5 percentage points to 4.75-5.0 percent. , and three days before the Bank of England held rates constant by 5 percent. The two the Fed and the BoE since cutting rates by 0.25 percentage points (on 7th November).

Since the near-term yield low, ten-year Treasury yields increased by 1.08 percentage points and ten-year gilt yields increased by 1.02 percentage points – to 4.7 percent and 4.8 percent respectively, increasing the annual which costs any new debt that is issued, and pushes down the value of existing bond holdings.

We know that nominal bond yields, and their changes, can be sliced ​​and diced into long-term inflation expectations (called breakeven inflation rates) and real yields (aka the amount you promised after accounting for inflation). How much is the yield increase due to the increase in inflation expectations? The others. But usually the rise in bond yields is due to the rise in real yields.

There’s no shortage of theories as to why inflation-linked bond yields should be trading where they’re trading, though there aren’t any flaws we’ve yet to find. They can almost considered salable r-star in financial markets – the best predictor of the market’s medium-term equilibrium real rate for the economy as a whole. Although some people think r-star is a load of baloney.

Real yields for gilts tend to be lower than for US Treasuries over the past decade. Going by the whole marketable r-star theory, you could be forgiven for thinking that this gap reflects the market’s expectations for a downward trend in economic growth. And, frankly, who knows? But a common belief among UK investors is that inflation-linked gilt yields are lower than you might expect because UK private sector defined benefit pension schemes tend to have inflation-linked liabilities – and many of these buyers are looking at lifting their risk can lower the linker yield to the bottom. level.

Here’s how real yields have progressed over the past few years:

With nominal bond yields roughly translated into expectations for average central bank policy rates over a time horizon, real yields squeezed below structural pension demand correspond to higher breakeven inflation rates. And this is an explanation for mandate-busting level of breakeven inflation rates that have been typical of the UK market for most of the past fifteen years.

Today the level of inflation that would equate the total return of a ten-year UK inflation-linked gilt to a ten-year conventional (non-inflation-linked) gilt is around 3.6 percent per annum. This is a lot of inflation. But this is not much different from the 3.3 percent annual breakeven inflation rate that the market has priced in on average over the past decade.

Breakeven rates and real yields aren’t the only way we can slice and dice changes in bond yields. As we learned from bond boot campyields also slice into market expectations of overnight interest rate swaps (the average policy rate that the market expects) and asset swaps (the amount that governments must pay to rent private sector balances sheet, aka term premia).

Much of the rise in 10-year bond yields in recent months is seen by the market as repricing the pace of individual central bank policy rates over the next decade. And this cool chart created using data provided by Christian Mueller-Glissmann from Goldman Sachs shows the degree to which longer-term bond yields have moved with expectations for short-term Fed rate action . In September the options markets were pricing in a sixty percent chance of eight or more cuts in the next twelve months. It now costs a 30 percent chance of one or more walking for the year.

But on this side of the pond, gilt yields rose slightly more than expected by the Bank of England alone. Lawrence Mutkin, head of EMEA rates strategy at BMO, points to this term premium as something that is increasingly becoming a big deal for bond markets around the world. As he said:

if Term Premia increases for the government, so will Term Premia for everyone. This is what “crowding” looks like.

How will central banks respond to rising term premia? Maybe by cutting rates? If so, this – argued Mutkin – is the fiscal dominance of the action. 😬

How did this term premia develop? Not good. While gilts have been cheapening against swaps in recent months, this has only brought them to the level already achieved by US Treasuries against their swap curve. Is this a result of QT/excess government issuance? Responses to comments please.

Now we know we have a lot of charts to give you. And although this is not usually the done thing, we really don’t see why we shouldn’t chuck these various slices and dicings into an overview of the graphic to show not only if what happened to the ten-year bond yield, but something else. tenor too.

So while the answer to the question “how much have bond yields risen since mid-September?” is “close to one percentage point for bonds with anything from five years to thirty years remaining before maturity in the Treasury and gilt markets alike”, the reason for these moves various:

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 only next year, but in next five, ten, even thirty years than they did. in the middle of September.

At the same time, the bond market’s measures of inflation expectations did not jump, but this could also be because the markets expect the Federal Reserve and the Bank of England to have higher interest rates than in the middle of September.

In the UK there are some cheap gilts against swaps, with ten-year gilts term premia rising rapidly to levels seen in the US Treasury market.

None of this will help you understand the intraday movements in bond markets that occurred yesterday – variously interpreted as a failure by investment banks to manage rate locks, to the consequences in an almost five-year gilt auction, to bond the vigilantes who tested the Chancellor’s skills. But we hope it provides some useful context.

Further reading:
— Good sales will continue until morale improves
— Everything you ever wanted to know about bonds (but were afraid to ask)