Gilts hit harder due to narrower liquidity vs peers

UK government bonds have been more heavily impacted by recent market turbulence than European Government Bonds and US Treasuries, largely due to narrower liquidity in the UK gilt market.

Bryn Jones, head of fixed income at Rathbones says: “It has seemingly got worse since the start of the recent conflict. We had expected a rise in yields, but the moves have been aggressive. They took futures from two rate cuts to one rate hike in the space of a week, which is exceptional behaviour from a G7 government bond market. But then there have been exceptional events going on in Middle East. Then to see that rate hike disappear in the next few hours, back to ‘no change’ in rates – that’s a lot of volatility.”

Jones continues: “We still think, structurally, the long end of the market looks attractive. Issuance has collapsed at the long-end, and QT is being massively reduced at the long-end. 

“Clearly, we have seen significant technical moves, going from overbought on Relative Strength Indicators (RSI) to oversold very quickly. Fundamentals though, are being questioned.” 

At the same time there are concerns that the UK will be impacted by the inflation caused by higher oil prices, adding to this negative loop.

Jones says: “A long, protracted war will have a negative impact on longer term inflation, hence why we have seen yields rise. It is difficult to predict President Trump’s behaviours, comments and moves and this ‘Trump Bingo’ has been going on for a while. The front end has also seen some aggressive repricing. If you think the inflation fed through is not going to be that bad, and a conclusion to this trouble is forthcoming, then clearly there could be a lot of value.” 

Liquidity dynamics in the gilt market are also under scrutiny. Bank of England Governor Andrew Bailey has previously raised concerns about the ease with which CTA and hedge fund strategies can short the gilt market, which can amplify selloffs during periods of market stress.