We love bonds, but we hate them being on the front page. Let's face it, while they are intellectually fascinating, there is no good news for the bond markets. It's always “someone defaults” or “someone is ruining the economy” or some other kind of atrocity.
It was hard for readers to miss the excellent coverage generated by rising bond yields over the past few months. Or already front page News of that I was born gilts on The last 24 hours.
There is an excellent explanation of what the current malaise means for the government – and for UK citizens more generally – On MainFT.
But we think it's worth asking a simpler, more surprising question: What happened to bonds over the past few months?
undo, Most of the time The best answer to the question “Why did government bond yields rise/fall?” It is the “treasury market”.
While government bonds do not move basis point for basis point with Treasuries – and the potential for divergence always exists – 10-year government bonds and 10-year Treasuries tend to drift together over the medium term. German bonds also tended to move in tandem with US government debt until the eurozone crisis put a damper on European growth.
After the EU referendum, government bond trading remained in limbo for a few years, and it has yet to be decided whether it will join the Bunds in ruling out a recession, or Treasuries in ruling out a recovery. After the Liz Truss mini-balance sheet shock in the fall of 2022, they are back trading largely in line with Treasuries.
The global rise in yields since mid-September may seem unremarkable on such a long-term chart. But the sell-offs are nonetheless interesting and important. First, because of the nature of the selling process. Second, because of the implications for other markets as well as government funding.
“Nature of sale”? Does FTAV get “Concepts'? Is there really anything more to be said than, “Get up the line,” Sad monkey“?
Yes indeed.
The last low point in US government bond and Treasury yields was on September 16, 2024 – two days before the Fed cut interest rates by 0.5 percentage point to 4.75-5.0 percent, and three days before the Bank of England. Maintained rates constant By 5 percent. both of them Federal Reserve Bank and Bank of England It has since cut interest rates by 0.25 percentage points (on November 7).
Since the rough yield decline, ten-year Treasury yields have increased by 1.08 percentage points and ten-year government bond yields have increased by 1.02 percentage points – to 4.7 percent and 4.8 percent, respectively, which increases the annual cost of any new debt issued. , pushing down the value of existing bond holdings.
We know that nominal bond yields, and changes in them, can be divided into long-term inflation expectations (so-called break-even inflation rates) and real yields (also known as the amount you are promised after accounting for inflation). How much of the increase in yields was due to rising inflation expectations? some. But the rise in bond yields is mostly due to rising real yields.
There is no shortage of theories as to why inflation-linked bond yields should trade where they do, although there are no disproven theories yet. They can barely It can be considered tradable r star From financial markets – the market's best guess as to the medium-run real equilibrium rate for the economy as a whole. Although some people think r-star is a load of bullshit.
Real yields on government bonds have tended to be lower than they have been for US Treasuries over the past decade. Given the fully tradable R-Star theory, you could be forgiven for thinking that this gap reflects market expectations of a lower economic growth trend. And honestly, who knows? But a Shared belief Among UK investors is that inflation-linked government bond yields are lower than you might expect because UK private sector defined benefit pension plans tend to have inflation-linked liabilities – and the sheer volume of these buyers looking to hedge their risks leads to lower Bond yields to lower levels.
Here's how real returns have evolved over the past few years:
With nominal bond yields roughly translated into expectations of average official central bank interest rates over a given time horizon, real yields deflated by structural demand for pensions will have a counterpart in higher break-even inflation rates. This is one explanation for Breach of authorization The level of break-even inflation rates that have been common in the UK market for most of the last fifteen years.
Today, the level of inflation that would equate the total return of 10-year UK inflation-linked bonds to 10-year conventional (non-inflation-linked) bonds is about 3.6 per cent per annum. That's a lot of inflation. But it's not radically different from the 3.3 percent annual inflation rate the market has been priced into on average over the past decade.
Break-even rates and real yields are not the only way we can slice and dice changes in bond yields. As we learned in Bond campYields also fall within market expectations for overnight interest rate swaps (the average interest rate that the market expects) and asset swaps (the amount governments have to pay to lease private sector balance sheets, also known as term premiums).
Most of the increase in 10-year bond yields in recent months is accounted for by the market's repricing of the path of the central bank's official interest rates over the next decade. This fascinating chart, prepared using data provided by Christian Müller-Glesmann of Goldman Sachs, shows the degree to which long-term bond yields have moved with expectations that the Fed will move its interest rate in the very short term. In September, options markets priced in a sixty percent chance of eight or more downgrades over the next twelve months. It now costs a 30 percent chance of one or more attacks Hiking For the year.
But on this side of the pond, government bond yields have increased slightly more than can be explained by the Bank of England's expected moves alone. Lawrence Motkin, head of EMEA interest rate strategy at BMO, refers to this premium term as something that is increasingly becoming a big deal for bond markets around the world. As he put it:
When the bonus period for the government increases, so does the bonus term for everyone else. This is what “congestion” looks like.
How might central banks respond to rising term premia? Maybe by lowering interest rates? If so, then this, says Motkin, is financial dominance at work. 😬
How was the term premia developed? Not well. While government bonds have fallen in value against swaps a lot in recent months, this only moves them to the levels that US Treasuries have already achieved against their swap curve. Is this a result of QT issuance/over government issuance? Answers in the comments please.
Now we realize that we have thrown a large number of schemes at you. Although this is not the thing that is typically done, we don't really see why we shouldn't bring these different slices and pieces together into a comprehensive graphical overview to show not only what happened to 10-year yields, but also to show what happened to 10-year yields. Other decimal bonds. Periods too.
So while the answer to the question “How much have bond yields risen since mid-September?” “Roughly one percentage point for bonds with anything from five to thirty years remaining before maturity in both the Treasury market and the gilt market.” The reason for these moves varies:
In both markets, the simple reason bond yields are rising is that the markets expect the Fed and the Bank of England to offer higher interest rates not just over the next year, but over the next five, 10, or even 30 years than has already been the case. In mid-September.
Meanwhile, bond market gauges of inflation expectations have not jumped, but this may also be because markets expect the Federal Reserve and Bank of England to have higher interest rates than they did in mid-September.
In the UK, there has been some reduction in government bond rates for swap bonds, with ten-year bond premiums rising rapidly towards levels seen in the US Treasury market.
None of this really helps you understand the intraday moves in bond markets that occurred yesterday — which have been variously interpreted as some sloppiness from investment banks in managing interest rate locks, to the results of the five-year government bond auction, to bond vigilantes testing their mettle. Counselor. 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)
