What’s up with bond yields?

We love bonds, but we hate it when they make the front page. Let’s face it, although they are intellectually interesting, there is no good news about bond markets. It’s always “someone’s defaulted”, “someone’s economy crashed”, or some other such monstrosity.

It was hard for readers to miss the excellent coverage that rising bond yields have generated over the past few months. Or indeed first page news that gilts have been generated on Last 24 hours.

Here’s a great explainer of what the current malaise means – for the government – and for UK citizens more generally. In Mainft.

But we think it’s worth unpacking a simple nerdier question: What has happened to bonds in the last few months?

step back, Most of the time The best answer to the question ‘Why are gilt yields up/down?’ is the ‘treasury market’.

While gilts do not move basis-point-for-basis-point with Treasuries — and the potential for deviations is ever-present — 10yr gilts and 10yr Treasuries tend to move together over the medium term. Bonds also tended to move in lock-step with US government debt until the eurozone crisis sped up European growth.

Gilts, which have been trading in limbo for years since the EU’s referendum, are undecided whether to join bonds in discounting economic stagnation, or Treasuries in discounting reflation. Following the Lease Truss mini-budget shock in the fall of 2022, they returned to trading in line with Treasuries.

The global rise in yields since mid-September may seem extraordinary on such a long-term chart. But selling off is nonetheless both interesting and important. First, because of the nature of the trade. Second, it has implications for other markets, as well as for government finances.

‘The nature of the sale’? Getting FTAV’idea‘? “Go up the line, The monkey is sad“?

Yes, actually.

Recent lows for gilts and US Treasury yields were on 16 September 2024 – two days before the Federal Reserve cut rates by 0.5 percentage points to 4.75–5.0 per cent and three days before the Bank of England. The retention rate is constant At 5 percent. Both Fed And BoE It has since cut rates by 0.25 percentage points (November 7).

Since that estimated yield low, the ten-year Treasury yield has risen 1.08 percentage points and the ten-year gilt yield has risen 1.02 percentage points — to 4.7 percent and 4.7 percent, respectively. 4.8 percent, raising the annual cost of issuing any new debt. , and pushing down the value of existing bond holdings.

We know that nominal bond yields, and changes in them, can be sliced ​​and diced between long-term inflation expectations (aka the breakeven inflation rate) and real yields (aka the amount promised after accounting for inflation). How much of the yield increase is due to an increase in inflation expectations? Something. But most of the increase in bond yields is due to increases in real yields.

There’s no shortage of theories about why inflation-linked bond yields should trade where they should, though none we’ve yet come across are falsifiable. they can almost Think like a business r-star Financial market – the market’s best estimate of the medium-term equilibrium real rate for the economy as a whole. Although some people think the R-Star is a load of crap.

Gilt real yields have tended to be lower than US Treasuries over the past decade. According to the whole tradable R-star theory, you could be forgiven for thinking that this gap reflects the market’s expectation of lower trend 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 the sheer size of these buyers lowers the linker yield to hedge their risk

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

With nominal bond yields roughly translating to the average central bank policy rate over a given time horizon, real yields held back by structural pension demand will be offset by higher breakeven inflation rates. And an explanation for this Mandate-busting The breakeven inflation rate level that has been typical of the UK market for most of the past fifteen years.

The level of inflation today that equates to the total return of ten-year UK inflation-linked gilts to ten-year conventional (non-inflation-linked) gilts would be around 3.6 per cent per annum. That’s a lot of inflation. But this is not very different from the annual breakeven inflation rate that the market has averaged over the last decade.

Breakeven rates and real yields aren’t the only ways we can change bond yields. As we have learned Bond Boot CampYields are also split between market expectations of overnight interest rate swaps (the average policy rate expected by the market) and asset swaps (the amount governments pay to rent out private sector balance sheets, aka term premiums).

Much of the rise in 10-year bond yields in recent months has been attributed to markets reassessing the course of the respective central bank’s policy rates over the next decade. And this excellent chart, made with data provided by Christian Mueller-Gleissmann from Goldman Sachs, shows that long-dated bond yields have moved with expectations for very short-term Fed rate action. Options markets in September priced a sixty percent chance of eight or more cuts over the next twelve months. It is now priced at a 30 percent chance of one or more Hikes for the year

But on this side of the pond, gilt yields rose slightly more than expected by Bank of England action alone. Lawrence Mutkin, head of EMEA rate 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 puts it:

When the term premium for the government increases, so does the term premium for everyone else. This is what “crowded out” looks like.

How can central banks respond to rising term premiums? Maybe lower the rate? If so, this is – argues Mutkin – revenue dominance in action. 😬

How did the term premia evolve? not good While gilts have fallen much lower against swaps in recent months, this only takes them to levels already achieved by US Treasuries against the swap curve. Is this the result of QT/overwhelming government issuance? Please reply in the comments.

Now we understand that we have sent you a large number of charts. And although it’s not usually done, we don’t really see why we shouldn’t chalk up these various slicing and dicings to a single overall graphic overview to show not only what happened to ten-year bond yields, but other tenors too.

So when “How much have bond yields risen since mid-September?” Answer the question. “In the Treasury and gilt markets around one percentage point for bonds with anything from five to thirty years to maturity”, the reasons for these moves vary:

In both markets, the simple reason bond yields are higher is that markets expect the Federal Reserve and the Bank of England to have higher interest rates than they have not just next year, but for the next five, ten, or even thirty years. In mid-September.

At the same time, bond market measures of inflation expectations have not jumped, but that may be because markets expect the Federal Reserve and the Bank of England to hold interest rates higher than they did in mid-September.

Gilt has been undervalued slightly against swaps in the UK, with ten-year gilt tenor premiums rising rapidly towards levels seen in the US Treasury market.

None of this helps you understand yesterday’s intra-day move in the bond market — variously explained as some laxity in handling the rate lock by investment banks, the outcome of the five-year gilt auction, bond vigilantes testing the Chancellor’s mettle. But we hope it provides some useful context.

Further reading:
– Sterling selling will continue until sentiment improves
– Everything You Always Wanted to Know About Bonds (But Were Afraid to Ask)