UK Treasury turmoil spreads to US and European markets
The turmoil in the UK sovereign debt has sent shockwaves through global markets, causing large swings in US and European bonds.
“Bond markets are always highly correlated, but we definitely saw the tail wag the dog this week,” said Dickie Hodges, head of unconstrained fixed income at Nomura Asset Management. “The movements in gilts have been so large that they have spilled over into the European and US bond markets.”
The 10-year US Treasury, the benchmark in the world’s largest and most important debt market, posted its biggest one-day rally since March 2020 on Wednesday after the Bank of England announced emergency bond purchases to halt the freefall in UK sovereign debt. These gains followed severe losses in global bond markets since last Friday, as the severe sell-off in gilts spread across the world.
Analysts and investors say some of the moves in Treasuries, or German Bunds, have been caused by leveraged investors – who use debt to augment their profits and losses – dumping easily traded assets elsewhere to cover their losses in the UK. But the similar – if much more muted – moves in the US and Europe also stem from the common challenges facing most major economies of how to rein in runaway inflation without stifling economic growth.
“While the UK is a basket to itself, the fact is the same pressures are being felt strongly elsewhere,” said Richard McGuire, rates strategist at Rabobank. “Investors are looking at the government’s ill-conceived experiment and wondering if it’s a sign of what’s to come in other countries.”
After Chancellor Kwasi Kwarteng’s £45bn package of tax cuts and energy subsidies last Friday, traders were quick to price in a stronger hike in UK interest rates, betting that the BoE would need to tighten monetary policy more quickly to mitigate the inflationary impact of fiscal stimulus to balance . Euro-zone markets also added expectations for an additional rate hike from the European Central Bank next year “out of sympathy,” McGuire said. He added that his clients who invest in eurozone government bonds currently have the UK high on their list of questions.
The global nature of monetary policy has also meant that when a central bank changes direction, such as when the BoE decided this week to delay its quantitative tightening process, questions are raised as to whether other central banks will follow suit.
“In the US market, we’re a bunch of unicellular monkeys. You see the Bank of England suddenly ending quantitative tightening, and you think the US might end quantitative tightening as well,” said Edward Al-Hussainy, a senior interest rate strategist at Columbia Threadneedle.
The aftershocks of the UK crisis have been particularly evident in the US due to volatile market conditions in general, analysts and investors said. Among global central banks, the US and UK are raising interest rates at a rapid pace, which has led to unusual price swings, even in markets that are typically ultra-stable, such as the US. B. with government bonds. 2- and 10-year treasury bills are both on course to record their biggest sell-offs of all time this year.
Given the historic shift in monetary policy this year, markets are expected to react significantly. But those moves have also been exacerbated as uncertainty about the future direction of monetary policy has marginalized more cautious investors. With fewer investors in the market, price swings become even more dramatic, a phenomenon some investors have described as a “volatility vortex.”
“In moments of higher volatility, everything correlates,” said John Briggs, head of US rates strategy at NatWest Markets.
“While what is happening in the UK should objectively not affect the Fed outlook or inflation, the fact is no one will be immune if markets move on this scale. Volatility breeds volatility,” Briggs said.
Two Fed officials this week hinted that the UK crisis could potentially create problems for the US. Atlanta Fed President Raphael Bostic said Britain’s tax plan and resulting market volatility could increase the chances of pushing the global economy into recession. New Boston Fed President Susan Collins also said that “a significant economic or geopolitical event could push our economy into recession if policy tightening continues.”
“Money moves back and forth to match the different national markets,” said Gregory Whiteley, portfolio manager at DoubleLine. “It’s a natural spillover as money moves between markets to take advantage of changing prices.”