Bond Watch: gilt yields surpass ‘mini-budget’ crisis

Sam Benstead breaks down the latest news affecting bond investors.

Welcome to interactive investor’s ‘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.

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Here’s what you need to know this week.

Gilt yields spike on inflation and rate worries

Rising wages in Britain has prompted traders to bet interest rates could rise to more than 5.5%, triggering a sell-off in UK government bonds (gilts).

Data released this week showed that average private sector wages rose 7.5% in the year to April. Consumer Price Inflation (CPI) was 8.7% in April, with core inflation, which strips out volatile items such as food and energy, rising from 6.2% to 6.8%, the highest level for 30 years.

Wage inflation is seen as “sticky” as wages don’t fall in the way that energy or food prices do.

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When bond prices fall, yields rise, meaning that yields on short-term debt, which is most sensitive to short-term changes in interest rates, are now around 5%. Two-year bond yields are now above the levels of the “mini-budget” crisis of late September 2022. Five-year bonds now yield 4.5%.

Source: Refinitiv. Two-year Gilt price as at 16 June 2023.

Higher borrowing costs are feeding into higher mortgage rates, which will deal a heavy blow to UK households. Two years on from the end of the stamp duty holiday, remortgages at higher rates are coming thick and fast.

Capital Economics, an analyst, calculates that just one-third of mortgage borrowers have remortgaged their cheap pandemic deals. It found that 3.2 million households are on deals of at least 3% currently, but that number will rise to 5.8 million by the end of 2024.

Over 700,000 fixed-rate deals are coming up for renewal this year alone – most of which were fixed at a rate below 2%, according to the Office for National Statistics.

Rate ‘pause’ in America as inflation drops to 4%

In contrast with high inflation in the UK, America saw price rises drop to 4% in the 12 months to May, compared with 4.9% in April. On a month-over-month basis, prices rose just 0.1%.

The good news prompted the Federal Reserve to pause its interest-rate hiking for the first time since March 2022. However, chair Jerome Powell suggested that there could be two more rate rises before the cycle is over for good. Interest rates in America are currently between 5% and 5.25%.

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Charles Hepworth, investment director at GAM Investments, said that the decision did not come as a surprise.

“The accompanying statement and press conference was, however, more hawkish than expected with the Federal Reserve expecting two additional hikes this year to tame inflation, which the central bank expects to move higher again,” he said.

Bond traders see rates ending the year around 5.6% in America. They have pulled bets that rates will be cut this year, as markets suggested at the beginning of the year.