The UK long-term bond yields – gilts – have been rising since the start of the year, especially the 30-year yields; they rose by 45 basis points even as the Bank of England has cut rates by 75 bp. Moreover, it is also worth considering that since the 10-year gilt yield rose by only 12 bp, the spread between the 30-year and 10-year gilts has widened. So what’s going on here?
Source of data: Investing.com
The main factors that usually affect the price of long-term bonds include: short-term interest rates, inflation expectations, and the term premium; the latter is the added return investors require to hold long-term bonds instead of investing in a series of short-term bonds; this premium encompasses factors such as inflation uncertainty, risk of changes to short-term rates, etc. While the term premium is expected to be positive, there were times when it wasn’t.
In the US, for example, the term premium had periods in which it was negative, and thus kept the long-term treasury bond yield very low, a phenomenon that the former Chair of the Federal Reserve, Ben Bernanke, dedicated an article to. Most recently, according to one estimate, the 10-year bond term premium was in negative territory briefly in 2023. However, the term premium has now been positive, and may even be rising in the UK, as long-term yields are climbing while short-term rates have been dropping.
The main culprits for rising LT gilts are likely higher public debt, rising inflationary pressures, and economic uncertainty – factors that have contributed to the rise in the term premium.
But why has the 30-year bond yield gone up so much more than the 10-year bond yield? The difference between the two is in their duration risk, but these bond yields shouldn’t diverge in their trend that much as they have this year.
Source of data: Investing.com
For one, it doesn’t seem to be a supply-side issue. I checked the data on the debt issuance by the UK government this year: Since the beginning of the year, according to the UK debt management office data, issuance of 30+ years of debt accounted for 8% of total debt, while maturities of 10 years or less were 60% — suggesting it’s less to do with bond issuance.
The remaining possible factors include bond market liquidity and concerns over the long-term prospects of the UK’s debt. Investors are less inclined to acquire a 30-year bond due to its higher duration risk relative to a 10-year bond.
However, this phenomenon isn’t exclusive to the UK; in the US, a similar trend has emerged, in which while the 30 bond yields didn’t rise, the 10-year bond yields have been falling.
Source of data: FRED
The last time the gap between these assets widened in the US was during the pandemic; hence, this trend may indicate markets are on edge over the economic outlook in both countries.
The bottom line is that the BoE’s job has just become harder as it weighs between lowering rates to boost economic growth and slowing down the normalization process as inflationary pressures mount.
