The UK 10-year gilt yield has hit its highest level since the financial crisis in 2008, while the 30-year yield is at its highest since 1998, prompting concerns about the road to recovery for the UK economy.

The latest data showed that the 10-year gilt yield had risen to 4.79 per cent, while the 30-year yield had increased to 5.35 per cent amid an intensified global government bond selloff.

With the UK government’s already limited budgetary headroom, the surge in gilt yields has raised concerns about how Chancellor, Rachel Reeves will respond as she looks to continue with her aim of ensuring economic growth.

Fidelity International portfolio manager, Mike Riddell, said that while the gilt selloff had grabbed headlines, where a common conclusion was to point fingers at the government, this would “miss the point”.

“It is mainly a global fixed income story,” he continued. “UK gilt yields are broadly moving with US Treasuries, where 30-year gilt yields have risen by no more than 30-year US Treasuries over the past couple of months. And there has been a similar sized move even in long-dated German government bonds in the last month.”

“That’s not to say that the UK has been immune to pressure. Although there’s not any sign of a UK crisis yet, a worrying development in recent days is that gilt yields have risen a little more than in other markets, at a time when sterling has sharply weakened.”

Riddell added that it was interesting that this was an unusual ‘bear steepening’ move, where longer-dated bond yields had risen by more than short-dated yields, which was indicative of fixed income investors becoming increasingly concerned about fiscal largesse, and all the government bond supply that accompanies it.

“It’s not about inflation concerns, where the market’s medium-term inflation expectations are little changed since the beginning of November. Investors are instead demanding a higher-risk premia or ‘term premia’ to compensate them for owning longer-dated government bonds.

“The obvious implication of this moves is that it’s just got a lot more expensive for everyone to refinance their debt. If this selloff continues, it’s going to push deficits wider over the long, which then risks a doom loop since deficits need to be funded by ever more sovereign issuance.

“But the positive news it that the potential return from owning government bonds has just got a lot higher too. If you buy a 30-year UK government bond today and hold to maturity, then assuming no default of course, the total return over the life of the bond is almost 400 per cent.”

AJ Bell head of investment analysis, Laith Khalaf, said that the surge in gilt yields so long after interest rates had peaked suggested that markets had been complacent about inflation and overly confident that rates would be cut more sharply.

“Rachel Reeves appears to be one potential culprit for rising bond yields, which is probably wide of the mark,” Khalaf continued.

“Reeves’ maiden Budget was marginally inflationary, and did increase overall government borrowing, but since the beginning of October the US and UK 10-year bond yields have tracked upwards almost hand in hand (see chart below).

“Those who think the current bout of bond market jitters is down to policies announced in the Budget need to explain why there has been such correlation in the upward march of bond yields both here and in the US.

“There are no easy answers to the question of why markets move, especially over a short time frame, and sometimes it’s simply a matter of momentum. However, the fact yields are rising on both sides of the Atlantic does suggest the new year has brought with it a focus on the incoming US president, and the potential for his trade and immigration policies to be inflationary, which has implications for both economies.

“Bond investors might also be looking at the giant stacks of government debt already on the books on both sides of the pond and saying thanks, but no thanks.

“Here in the UK higher yields put pressure on government finances and increase the risk that Reeves will come back with another tax raising Budget.

“A big saving grace is that the new Chancellor has limited herself to one Budget per year, and so while we will get an updated set of forecasts from the OBR in March, which will lay bare the state of government finances, we don’t expect Reeves will have to balance the books though tax policies until the back end of the year.

“That gives plenty of time for the bond market to calm down, though that in turn will of course depend on whether global inflation actually rears its head again in 2025.”

Khalaf noted that the current bond market selloff could be a ‘storm in a teacup’ but, if higher rates get baked in, equity investors could start to question their exposure, especially in the US.

However, while existing bond investors will be experiencing come modest losses due to the latest selloff, fresh bond investors may be “licking their lips” as yields rise and they are able to lock into higher rates, Khalaf concluded.

This article originally appeared on our sister title, Wealth Investment News.

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