Market investors continuously look for patterns in asset behaviour. One significant relationship is the response of yields on UK Government Bonds (Gilts) to changes in their US counterparts (Treasuries). Following rises in US interest rates the Federal Reserve is expected to begin unwinding its balance sheet. In other words the US government will stop quantitative easing (printing money to invest in its own debt) and actually ask itself for some of this money back. These actions are expected to raise the returns demanded by buyers of US Treasuries. How soon before the Bank of England moves its own interest rates upwards? How will gilt yields react?
Over the last month there has been rising evidence of coordination of central banks calling time on extraordinary monetary policy. In Sintra, Portugal, both Mario Draghi and Mark Carney, Heads of the European Central Bank and Bank of England respectively, intimated that markets should prepare for a sea change in policy. So, the market reduced the value of Eurozone and UK Government Bonds in anticipation of interest rates rising. Canada became the second G7 country to raise rates. Although the Federal Reserve set the hare running in 2015, it had not said when it would unwind quantitative easing, by not reinvesting the proceeds of redeeming US Treasuries. Its announcement this week of unchanged interest rates was interpreted as indicating the great unwind would start in September.
UK interest rates are at 300 year lows and have not been moved upwards in a decade. The economy could well be on the edge of a slowdown as Brexit-related fears begin to impact corporate investment intentions, consumer confidence and savings drop. On top of this, the UK government’s finances have worsened over the past year. They are borrowing more now. If the historic positive relationship between UK interest rates and those in the US prevails in coming months, it follows gilt yields could move upwards as well, perhaps as soon as the next Bank of England meeting on 03 August. Yields move in the opposite direction to the price of a bond. With such low interest rates, it does not take much of a fall in the capital value of a bond to wipe out several years of income as a result. Caveat Emptor!