Rising UK GILT Yields & the Implications for Investors

What happened?
Global government bond yields rose sharply last week (meaning the price of government bonds fell), continuing the trend from the last quarter of 2024. UK yields, in particular, have spiked, driven by concerns over global inflation, potential tariffs under the new Trump administration, and the UK's long-term debt and growth prospects. While significant, these moves reflect the UK's weak fiscal position (when the government is spending more money than it earns) but remain within reasonable ranges, and not showing the same dynamics the so called “Gilt Crisis” of September 2022 when yields increased very quickly.

What has been the impact on markets?
UK 30-year government bond (also known as a gilt) yields have reached their highest levels since 1998. The pound has also fallen 2.4% this year to $1.22 (to 14th January), its lowest in over a year, due to a strengthening US dollar. While global factors are at play, local issues are affecting UK markets namely; (1) persistently high inflation, (2) increased government spending and a larger budget gap in the near term from the Labour government's October budget, and (3) pressure on the bond market from budget deficits, fewer long-term gilts being issued, and the Bank of England selling bonds. Pension funds are buying fewer gilts, making the market more reliant on foreign investors and investment funds.

Parallels with the 2022 Gilt Market Crisis
While there are similarities to the rise in UK government bond yields during September and October 2022, there are key differences this time. The current rise has been less severe and rapid. In 2022, 10-year gilt yields rose 1% within three trading days of the budget announcement. In contrast, since mid-October 2024 to 8th January 2025, equivalent yields have risen around 0.75% - closely tracking a similar 0.7% increase in US yields. While the movements are material, the increases have remained slower and smaller compared to the spikes seen in 2022 and March 2020. See chart below. Additionally, market pressure has eased recently, with no evidence of the disorderly sales or "forced selling" by pension schemes that characterised the 2022 gilts crisis. 

Portfolio implications
We continue to believe investing globally in bond portfolios will help limit overconcentration in any one particular economy, thus aiming to protect overall portfolio returns. 

Source: FactSet
10-year UK gilt yield shown by Spot yield United Kingdom benchmark bond 10 year

The Noise

• UK inflation slowed to 2.5% year-on-year in December from 2.6% in November which was below market expectations. Restaurants and hotels were the main contributors to this slowdown, with a notable 1.9% fall in prices of hotels. Hence, consumers might find that staycations could feel relatively cheaper in the coming months. These inflation figures sparked a gilt rally with 10-year gilt yields falling (and thus prices rising as price and yield work inversely) from 4.89% at Tuesday’s close to 4.73% at Wednesday’s close, having touched their highest level since 2008 last week. This provides some relief to the Chancellor who is under pressure due to the high long-term borrowing costs facing the Treasury. The lower-than-expected inflation rate could also influence the Bank of England (BoE) at their next rate-decision meeting at the start of next month. Markets have now priced in a higher likelihood of a UK interest rate cut next month, sitting at c.90% on Friday.

• US inflation rose for a third consecutive month to 2.9% in December from 2.7% in November, in line with market expectations. Food and transportation were the mains factors which contributed to this sustained growth in prices with the annual core consumer price index (CPI), which excludes volatile items such as food and energy, easing to 3.2%. Core CPI had plateaued at 3.3% for the last three months and came in slightly under market expectations of a continuation at 3.3% this month. Markets reacted positively to this data from the Bureau of Labor Statistics, with US equity markets rallying 1.5% on the day. However, these figures have reinforced the Federal Reserve’s dovish 2025 rate cut outlook, with inflation rates incrementally edging away from their 2% target. Markets are now pricing in roughly 50-50 chances of two quarter-point rate cuts in 2025.  ​

• The UK’s economy expanded 1% year-on-year in November 2024, which came in under expectations of 1.3%. This can be contextualised as a deflated figure as from 1998 to 2024 the UK’s GDP grew at an average rate of 1.85%. Since the October Budget, GDP data from the Office for National Statistics (ONS) has failed to beat expectations, signalling sustained sluggishness in UK growth and exacerbating fears of ‘stagflation’ which is a combination of high inflation, stagnant economic growth, and elevated unemployment. Pressure is mounting on Chancellor Rachel Reeves as the current Labour government put growth at the heart of their political agenda, but this has not followed through to the economy just yet.

The Numbers

GBP Performance to 16/01/2025

Source: Bloomberg, data as at 16/01/2025

The Nuance

The California wildfires have devastated parts of Los Angeles in recent days. Over 10,000 structures have been destroyed and the landscape has been ravaged, with whole neighbourhoods being reduced to ashes from Pacific Palisades to Malibu beach. Over 770 acres continue to burn, which equates to over 3,140 square kilometres. In this piece, we focus on the impact that these events could have on the US economy.

To quantify the damage these fires have had, the loss from the fires is estimated to be worth between $250 billion (£205bn) and $275 billion (£225bn), according to recent data from AccuWeather Inc. In economic terms, Goldman Sachs expect the LA wildfires will lower first-quarter GDP growth by about 0.2 percentage points. In essence, the Californian catastrophe is forecast to be the costliest fire in US history.

Insurers are bracing for additional losses of as much as $20bn (£16bn). In response, insurance companies are refusing renewal for 69% of policies in the Pacific Palisades area, which equates to around 72,000 homes. This is a widening trend amongst insurers to pull out of vulnerable markets and geographies, as climate change continues to perpetuate extreme weather.

In response to these fires, multiple lawsuits have been filed against Californian utility companies alleging they exacerbated the fires by failing to properly shut off power lines. The largest cost of these calamities is undoubtedly the 25 lives taken.

Climate change plays a large role in wildfires, with warmer temperatures, reduced rainfall, and extended periods of drought resulting in places like California being more fire-prone than ever. This catastrophe is a reminder of the importance of adapting to climate change, which is not possible without support from political and public authorities. 
 

The Niche

A fun financial markets fact of the week

In 1954, economist Armen Alchian figured out the composition of the secret fuel used to develop the newly produced hydrogen bombs by using the stock market. He worked this out by analysing chemical companies and their highly inflated share prices!