UK Bond Crisis: A New Risk Premium for the Government

A recent budget presentation by Finance Minister Rachel Reeves threw the financial markets into turmoil, as the yields on UK government bonds nearly reached their highest levels since the 2008 financial crisis. The announced extensive borrowing led to two days of turbulent trading, and on Thursday afternoon the British pound weakened – a development that strongly recalled the unfortunate "mini" budget of Prime Minister Liz Truss two years ago. The yield on 10-year gilts rose to as much as 4.53 percent on Thursday, close to the 2022 high of 4.63 percent, before stabilizing at 4.40 percent on Friday. Many investors, however, tempered the comparison to the more dramatic sell-off two years ago. Nevertheless, they stressed that Reeves' plans would have lasting impacts on the government's borrowing costs. "The movement signals a kind of rejection of the budget itself and leads to a new fiscal risk premium," explained Mark McCormick from TD Securities. The push to maximize funding potential had noticeably increased the risk. The rise in yields surprised many traders, who had hoped for a bond recovery once the budget was over, and indicated a new phase of tension between bond investors and the Treasury. As James Athey from the Marlborough Group noted, a risk premium exists, even though the current environment is very different from that of two years ago. Although investors expected higher debt needs in the Reeves budget, they were surprised by the scope – an additional £30 billion per year – as well as the resulting higher expectations for interest and yield levels. A comparison with Truss's mini-budget was dismissed as far-fetched, yet described as "neither Truss nor good," according to Nick Hayes from Axa Investment Managers. Wednesday's budget presentation was a "rollercoaster ride," according to an investor, with sentiment initially lifting, but then quickly turning negative as the extent of the planned borrowing became clear. Interest-bearing two-year gilts were particularly hard hit. The sell-off continued on Thursday, as investors expressed doubts about the realistic assessment of revenue sources and savings potential. Further concerns were caused by global bond markets, particularly as political uncertainties in the US and rising yields on US Treasuries triggered similar movements in Europe. Despite Reeves' assurances of stability, some wondered, with an eye on Halloween week, if she had "spooked" the market. Investors remain skeptical of a return to low yields and see a higher interest rate trend as structurally given in light of geopolitical tensions. The rising borrowing costs could cost Reeves considerable room to maneuver in managing the state finances. Moody's analysts warn that the affordability of government debt remains weaker than before the pandemic.