UK Bonds Join Global Rally As Traders Wait For Fiscal Plan
The gains came as investors waited for details from the government’s fiscal plans due on Oct. 31.
(Bloomberg) -- UK government bonds rallied for a second day as traders pared bets on how much tightening the Bank of England will deliver over the coming months and held out for more signs of fiscal rectitude from Prime Minister Rishi Sunak’s administration.
The gains accelerated after weak US housing data spurred wagers that central banks will hesitate to raise rates aggressively as the economy begins to cool. Swaps tied to central bank meeting dates see the Bank of England’s key rate peaking just below 5% in 2023, down from as high as 6.25% last month.
The moves filtered across the gilt and currency market. The yield on 10-year government bonds slipped as much as 18 basis points to 3.57%, approaching levels last seen before Liz Truss unveiled plans for vast unfunded tax cuts that sent the nation’s markets into turmoil. The pound rose as much as 2% to $1.1499, the highest level since Sept. 15.
The gains came as investors waited for details from the government’s fiscal plans due on Oct. 31. They’re still looking for a firm commitment that officials will follow through with plans to reverse the majority of Truss’ policies.
“Financial markets and foreign investors are looking for confirmation that the next government is committed to a fiscal policy path that the country can afford,” said Stephane Monier, chief investment officer at Lombard Odier. He thinks the BOE’s key rate will peak at 4.5% late this year or early next to avoid “further damaging the sensitive housing market.”
Sunak confirmed Tuesday that he will keep the architect of the U-Turn, Jeremy Hunt, as Chancellor of the Exchequer. There’s also a widespread expectation that the new prime minister will keep the budget on Oct. 31 and commit to more fiscal tightening.
That would be a “fiscal slam dunk for gilts,” said Antoine Bouvet, a rates strategist at ING Bank NV. “Let’s see if they hold. If not, we’ll see the gilt political risk rise again.”
Low Conviction
Despite their gains, gilts underperformed peers, a sign of the market’s nervousness over a fresh selloff. On Monday, trading volumes in 10-year bond futures expiring in December fell to a two-week low and were running at less than a third of levels seen a month ago, pointing to the lack of conviction in the rally.
“Political risk premia has rightly dissipated, but we still suspect that investors will be reluctant to engage with the gilt market until Hunt delivers his budget,” Peter McCallum, rates strategist at Mizuho International Plc, wrote in a client note.
In the currency market, the pound is poised to eke out its first monthly gain since May and options pricing suggests that its gains are deterring traders from adding to bets for more weakness, even as the premium to own such exposure has halved in the past two weeks.
Still, even a fiscally responsible statement may not be enough reason to buy the currency, said Jane Foley, senior currency strategist at Rabobank. Lombard Odier’s Monier sees the pound eventually falling below $1.05 as the UK economy stagnates.
“UK fundamentals are not good and the gilt market has now got to grapple with the possibility of quantitative tightening,” Foley said. “The fact is that unfunded tax cuts may be removed and that’s a relief for gilt investors, but there’s still quantitative tightening on the horizon and a large amount of debt in the UK.”
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(Updates prices and context throughout.)
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