As a result of Chancellor Kwasi Kwarteng’s mini-budget, the value of British government bonds has plummeted, as investors are frightened by sky-high spending commitments and huge tax cuts.
Five-year gilts are on track for a record one-day decline, with yields rising 50 basis points, while two-year gilts are poised for their worst trading day since 2009, based on current projections.
The mini-budget, which vowed to halt a ‘vicious cycle of stagnation,’ also exerted additional pressure on the sterling, which fell to within striking distance of $1.10.
By late morning, the FTSE 100 and FTSE 250 were down 1.5% and 1.2%, respectively, following a poor start to the day for London-listed firms.
Two, five, and ten-year gilt rates increased by 35 basis points, 50 basis points, and 41 basis points, respectively, to between 3.73 and 3.95 percent by mid-morning trade – one of the steepest one-day increases on record.
As Britain’s economic outlook has worsened over the past month, gilt yields have increased, with the 10-year offering a yield of less than 1% at the beginning of the year.
When a country borrows money, it issues bonds, which international investors purchase in exchange for a regular and guaranteed income stream from the issuing country. The term for these periodic interest payments is coupon payments.
The price of a bond is inversely proportional to its yield. This indicates that when bonds are sold, their value decreases, but the buyer is typically compensated with a higher yield.
UK government bonds – gilts – are issued with two-year, five-year, ten-year, and thirty-year maturities, which are the repayment periods for the debt.
It will set off alarm bells at HM Treasury, as the cost of servicing the nation’s debt grows in tandem with a rise in government borrowing and a decline in tax revenues.
Neil Wilson, Markets.com’s top market analyst, remarked, “Bond vigilantes have always been biding their time.”
The bond market’s response to the misnamed mini-Budget (it was anything but tiny) was remarkable, with rates soaring after the Chancellor disclosed sweeping tax cuts that abandon any sense of fiscal responsibility.
It implies increased borrowing and borrowing expenses. This is not the response any Chancellor desires from a budget, but what else could he have anticipated?
Simon Harvey, head of FX analysis at Monex Europe, added, ‘Within today’s budget, the worst worries of some investors were confirmed.
To encourage growth and expand the supply side of the economy through tax incentives and reform, the Chancellor failed to identify any measures for fiscal consolidation in the form of spending reductions.
In the absence of revised predictions from the OBR, markets were left to determine if the most recent fiscal pronouncement was sustainable.
The markets remain somewhat skeptical about the government’s ability to meet its spending commitments without issuing additional debt.
Sam Benstead, a collectives expert at Interactive Investor, concurred that while Kwarteng “did admit that budgetary restraint was vital,” the Chancellor “provided no hint of this position in his mini-budget” and consequently frightened bond markets.
The yield on the 10-year gilt, which swings inversely to bond prices, has increased from 0.8% to 3.8% over the past year, as bond investors worry about an increasingly indebted government that is attempting to spend its way out of problems even as inflation approaches double digits.
The Bank of England decided to increase interest rates by 0.5 percentage points to 2.25 percent on Thursday, which caught investors off guard and led to a drop in sterling and gilts.
According to the markets, investors now anticipate that the Bank of England will raise rates to as much as 5 percent during this cycle.
However, a deteriorating economic outlook and a growing negative attitude among investors may render this difficult.
Mohammed Kazmi, portfolio manager at Union Bancaire Privée, stated, ‘While the United Kingdom is experiencing an inflation problem, a poor growth outlook makes it uncertain whether they will be able to hike to such an extent at the end, where we believe such elevated pricing is due to the repricing of rates observed elsewhere and not just UK fundamentals alone.
Due to the Bank of England’s limited indication on future policy moves [yesterday], we anticipate that gilts will continue to be volatile as we await incoming data.
