Gilt yields and sterling rise on prospect of higher interest rates

Week of September 15

Last week, we saw government bond prices fall and yields rise strongly around the world, as concerns over geopolitical tensions and tropical storms finally started to ease. The 10-year US Treasury benchmark rate climbed 14 basis points in the first three days, while the same-maturity German Bund ended the week 12 basis points higher. Over the same period, US stock market indices posted new highs, as some investors shifted their money back into riskier assets.

British Gilts were the biggest losers during the global bond market sell-off. The 10-year bellwether soared an additional 16 basis points during the second half of the week, taking the total climb for the 5-day period to 31 basis points. Yields rose sharply over the entire maturity spectrum, with increases ranging from 25 basis points at the 2-year point and the very long end of the curve to 33 basis points for the 5-year rate. The surges followed Thursday’s Bank of England (BoE) meeting, in which a majority of Monetary Policy Committee members considered “some withdrawal of monetary stimulus…likely to be appropriate over the coming months”. Market participants interpreted this as a signal that a rate hike is probable in the near future, maybe as early as November.

Also fuelled by the prospect of higher interest rates and a general boost in risk appetites, the pound continued its recent rebound, gaining another 3% against the USD. Short-horizon risk for the GBP/USD exchange rate, too, increased by 0.2%, ending the week at almost 9%. The yen saw a similar rise in predicted volatility. However, here it was caused by a sharp depreciation against the dollar, as investors abandoned safe-haven investments to pursue higher-yielding asset classes.

Meanwhile, short-term risk in Axioma’s global multi-asset class model portfolio further decreased by 0.40% to 3.49%. The decline in overall volatility occurred despite significantly higher standalone standard deviations for both stock and fixed income securities. However, as this coincided with a more negative correlation between equity and interest rate factor returns, it led to a marked increase in the diversification effect of almost an entire percentage point. The oil future holding in the portfolio also saw a notable increase in its negative relationship with debt securities and non-USD assets, which resulted in it actively reducing portfolio risk by 5 basis points (or -1.5% of total volatility).

Christoph Schon, CFA, CIPM

Christoph Schon is the Executive Director, Applied Research for EMEA at Axioma, where he generates insights into recent risk trends with a particular focus on fixed income and multi-asset class analysis. Christoph has been in the portfolio risk and performance analysis space for more than 10 years, having previously worked for Lehman Brothers/Barclays POINT and UBS Delta.