The last few weeks has seen a crash in a sector of the markets, not in some obscure corner, but one of the most heavily traded assets of the lot – government bonds. Central banks, and what the markets expect them to do next, lies behind it.
The value of a bond is the inverse of its yield. If the yield is low, that means you need to buy more bonds to generate a certain level of income, hence they are more expensive. This year, the yield on UK government bonds fell to an all-time low, and consequently the price of these bonds hit an all-time high.
For example, as recently as early August, the yield on ten-year UK government bonds was down to 0.52%, meaning that the UK government could borrow for ten years at that rate. But a couple of days ago, the yield was up to 0.91%, meaning it had risen by some 76% – meaning the price had crashed.
So what is going on?
The movements are partly down to an expectation of a rate hike from the Fed next week, although frankly the Fed seems to change its mind every few days.
The Bank of England is also having an impact.
Yesterday, its rate-setting committee, the MPC, voted to keep rates on hold. But the minutes of the meeting suggest that the majority of the nine MPC members expect to vote for a rate cut in November – unless things change.
Data on the US economy is all over the place. However, data out yesterday suggested that both US retail sales and industrial production fell in August – minus 0.3% and minus 0.4% respectively.
The response from the markets is odd.
If anything, data out of the US in recent weeks has reduced the case for a US rate hike, while the Bank of England still seems to be warning of another rate cut soon.
These are not the circumstances in which you might expect bond prices to go up.
Maybe then the reasoning behind market movements in bond yields is different, the markets seems to have revised their expectation of interest rates in the years to come, upwards.
