Bond Boss: where next after 30-year gilt yields hit headlines?

Some investments hit the news for the right reasons: the FTSE 100 up 10%, the Aberdeen Group (LSE:ABDN) share price hits year-to-date high! But as a rule, if UK gilts are being discussed anywhere outside my government bond team, something’s gone awry.

After all, who can forget that ill-fated day back in September 2022, when then-Prime Minister Liz Truss’ “mini-budget” broke the gilt market?

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This summer, gilt yields have unfortunately been back under the spotlight.

Headlines such as “Gilt yields at levels not seen since the late 1990s” are unsettling. Mentions of International Monetary Fund (IMF) bailouts can give investors sleepless nights.

So, the question I ask my team is this: is all this negativity justified – and if not, is there an investment opportunity?

Gilt yields are higher than under Truss - but should investors worry?

Yes, 30-year gilt yields are higher than under Liz Truss. But while this is notable, it’s not necessarily cause for panic.

The key difference between now and 2022? Pace. Back then, yields spiked in a matter of days. This time, they’ve been rising gradually over weeks and months. A slow grind, not a sudden shock.

And the UK isn’t alone. Longer-dated government bonds from Japan to the US have been on an upward trajectory, driven by increased issuance and rising inflation. A steeper yield curve has been the story of the summer (see our separate ‘Is It cake?’ article).

A yield curve is a graph that illustrates the interest (or “yield”) earned on bonds depending on how long you lend your money - ranging from short-term periods such as two years to long-term ones like 30 years. Typically, the longer the lending period, the higher the expected interest, which results in an upward-sloping curve.

Crucially, sterling remains stable and gilt auctions have been well subscribed. International investors are still buying – they’re just asking for a bit more yield in return.  

‘Black holes’ and the UK’s public finances

Markets may be taking the rise in gilt yields in their stride, but there are grounds for concern from a fiscal perspective.

As yields rise, so do the government’s borrowing costs. The fiscal “black hole” – this summer’s buzzword – deepens every time the gilt curve shifts higher. That matters to UK policymakers and taxpayers alike.

Chancellor Rachel Reeves is keeping a keen eye on borrowing costs.

What are the key drivers of gilt yields from here?

In short: inflation and November’s Autumn Budget.

Inflation

At 3.8%, inflation is still uncomfortably high. This is no surprise, least of all to the Bank of England.

Nonetheless, the Bank expects inflation to fall back towards 2% target by 2026. This could pave the way for further rate cuts in 2025 and into next year. Markets disagree, pricing in just one full rate cut in May 2026.

In our view, inflation should peak this month. That could help bring down gilt yields across the curve, including the longer end.    

The Autumn Budget  

On 26 November, Chancellor Reeves will deliver her second Autumn Budget against an unforgiving political, economic and market backdrop.

The UK doesn’t have the worst fiscal outlook in the G10. However, it doesn’t have the exorbitant privilege of the US nor the collective strength of the eurozone behind it. Any budgetary missteps will be punished.

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We don’t doubt Reeves will comply with the government’s fiscal rules. The real question is how she complies.

In her 2024 Budget, she stood firm but raised National Insurance, adding billions to the debt pile and increasing gilt issuance, all while risking higher inflation. In the March Spring Statement, she again stuck to the rules and leaned into a growth narrative – yet still added billions more in gilt issuance.

In other words, complying with the fiscal rules isn’t enough.

What can the chancellor do to appease the gilt market?

One thing is certain – tax hikes are coming. Additional spending cuts could help support gilts, but what markets really want to see is action on mounting welfare spending. This summer’s aborted attempt at benefit reform doesn’t bode well. The government-led review on the issue is due in 2026.

Which brings us back to tax. For years, UK chancellors from both major parties have met their own fiscal rules by pencilling in future tax hikes and spending cuts. The market has lost patience with that trick.

This time, Reeves needs to act – not just promise. Tax hikes must kick in almost immediately to show she’s serious and to help contain gilt issuance over the coming year. Unlike 2024, gilt issuance cannot go materially higher.

And given the current climate, those tax hikes can’t fuel inflation. If Reeves can mechanically lower inflation – say, by reducing VAT on energy – even better.

Why we still like 30-year gilts

Despite all this, we still like gilts. A 30-year yield of around 5.50% is hard to ignore – especially if you believe yields are headed lower.

Inflation should fall and the Budget-related risk premium unwind heading into 2026. We expect long-dated yields to follow suit. Lower inflation should also give the Bank of England room to cut rates more aggressively than markets currently expect, driving yields lower still across the curve.

Of course, we still need to get through the Autumn Budget. Markets will remain jittery up until 26 November. But after several missteps, Reeves has a real opportunity to rebuild confidence in UK gilts.

If she succeeds, yields could finally start to fall – and gilts could quietly exit the headlines.

Here’s hoping the next gilt story is a dull one.

A big thank you to Matthew Amis and my rates team for sharing their expertise and thoughtful perspectives on this topic.

Jonathan Mondillo is global head of fixed income at Aberdeen.