Long yields fall and UK curve flattens after ‘dovish’ BoE rate hike

Week of November 3

Last week, we saw government bond yields fall around the globe. The 10-year US Treasury rate dropped 6 basis points on Monday, following reports that the tax reforms planned by the current administration could be phased in gradually over a 4-year period, while markets may have hoped for a quicker implementation. The indictment of three former Trump aides in connection with potential links to Russia during the presidential election campaign added further pressure on both equity markets and interest rates. The American bellwether rate descended another 3 basis points on Thursday—bringing the total decline for the week to 9 basis points—driven by its British counterpart, which also dropped by 9 basis points, following the Bank of England’s monthly meeting.

The British government yield curve flattened as a result, as the very short end was lifted by the Bank of England’s decision to raise rates by 25 basis points. Although the hike had been widely anticipated, the bond market’s reaction indicates that investors revised their interest rate expectations downward. The 2-year point on the Gilt curve remains firmly below the current base rate of 0.50% and overnight index futures have priced in two further 25-basis point rate increases over the next 1-3 years.

Currency traders pushed out their expectations regarding further action by the Monetary Policy Committee, too, and the pound lost 0.3% against the US dollar. The biggest 1-day decline occurred also on Thursday, when the GBP/USD exchange rate dropped by almost 1.5%. Sterling short-horizon risk rose by 0.05% to 8.81%, making it the most-volatile developed-market currency. In comparison, predicted volatility for USD/JPY stands at 8.61%, while CHF and EUR are around 6.60% each.

Meanwhile, short-term risk in Axioma’s global multi-asset class model portfolio was marginally lower at 3.06%, compared with 3.12% the previous weekend. The decline was mostly driven by lower equity and exchange rate volatility, although some of this was offset by a less negative correlation between stock and bond returns.

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.