Bond Watch: gilts hit as investors bet against Britain

Sam Benstead runs through the most important news stories of the week for bond investors.

Welcome to interactive investor’s new weekly ‘Bond Watch’ series, covering the latest market and economic news – as well as analysis – that is relevant to bond investors.

Our goal is to make the notoriously complicated world of bond investing simpler, by analysing the week’s most important news and distilling it into a short, useful and accessible article for DIY investors.

Here’s what you need to know this week.

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Cost of borrowing soars for the government

The big story this week from the bond world is that investors have ramped up their bets against the British economy and its government debt, known as gilts.

The UK 10-year government bond yield moved from 2.5% at the start of the week to 2.9% today as a result of markets losing confidence in the Bank of England to control inflation. In addition, markets have moved to factor in a brewing economic crisis due to sky-high energy bills as the weather begins to get cooler. The same bond had a yield of about 1% a year ago.

Bond yields move inversely to price: the L&G All Stocks Gilt Index Trust, which tracks a basket of UK government bonds, fell 6.6% in August and is down 18% this year.

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The Financial Times reported that foreign investors ditched £16.6 billion worth of gilts in July, the biggest sell-off in the market in four years.

Sterling has also taken a hit, with £1 now buying just $1.16, a 16% decline over the past 12 months.

A new prime minister will be announced next week, with front-runner Liz Truss pledging to cut taxes and increase spending, all fuelled by borrowing.

This is adding to the negative sentiment among bond investors, who are already worried about the UK economy and are unwilling to lend to the UK government at rock-bottom rates.

Markets are now betting that interest rates will top 4% in Britain next year, from 1.75% today.

Buyers of “safe” UK government bonds have been hammered this year, but the worst could still be to come as households begin to pay even higher energy prices from October and a weak pound hurts businesses that rely on imports.

Fed to ‘keep at it until the job is done’

US Federal Reserve boss Jerome Powell made a very “hawkish” speech last week at the Jackson Hole annual central bankers’ summit. Markets interpreted his comments as a sign that interest rates would rise more than they expected and stay high for longer.

Referencing stubborn inflation in the 1970s that was stamped out only by increasing interest rates from 11% to 20% over just two years by Paul Volcker, Powell said “we will keep at it until we are confident the job is done”.

Powell went on: “History shows that the employment costs of bringing down inflation are likely to increase with delay, as high inflation becomes more entrenched in wage and price setting. The successful Volcker disinflation in the early 1980s followed multiple failed attempts to lower inflation over the previous 15 years.

“A lengthy period of very restrictive monetary policy was ultimately needed to stem the high inflation and start the process of getting inflation down to the low and stable levels that were the norm until the spring of last year. Our aim is to avoid that outcome by acting with resolve now.”

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This wrong-footed markets, triggering a five-day 5% fall for the S&P 500, and sending bond yields higher because of the anticipation of higher interest rates.

Powell’s comments suggest that interest rates in America will be higher for longer, which went against a budding consensus among investors that he would “pivot” to cutting rates next year due to lower inflation