U.K. Bond Yield Falls to Record Low as Brexit Vote Approaches

U.K. 10-Year Gilt Yield Drops to Record Low
  • Gilts rise with Treasuries, bunds as investors favor havens
  • Germany’s benchmark bond yield also declines to record

The U.K.’s 10-year government bond yield dropped to a record just two weeks before the nation’s referendum on European Union membership.

Gilts rallied with Treasuries and German bunds with investors seeking havens as global economic optimism cools, and before Britain votes June 23 on whether to remain in the bloc. The Bank of England may ease policy if the nation decides to leave, according to Mohit Kumar, head of rates strategy at Credit Agricole SA’s corporate and investment bank unit. That’s supporting the U.K.’s sovereign debt, even as concern it may quit the EU has made the pound the worst-performing Group-of-10 currency this year.

“Gilts and government bonds are driven by risk aversion and position-squaring into the referendum,” said Kumar. “Investors would be wary to have much risk over the vote given the binary nature of the event. So, fixed income should rally. And if the U.K. does vote to leave, the Bank of England would go much more dovish, and that is bullish for the front end of the U.K. government-bond yield curve.”

U.K. 10-year gilt yields fell one basis point, or 0.01 percentage point, to 1.24 percent as of 4:24 p.m. London time. It earlier touched 1.218 percent, the lowest since Bloomberg started tracking the data in 1989. The 2 percent security due in September 2025 rose 0.085, or 85 pence per 1,000-pound ($1,447) face amount, to 106.585.

The yield on German 10-year bonds dropped two basis points to 0.04 and earlier reached a record low 0.023 percent. Treasury 10-year note yields declined two basis points to 1.68 percent.

The pound weakened 0.2 percent to $1.4474. It’s down 1.8 percent against the U.S. currency this year.

Brexit Risk

“There is definitely Brexit risk in gilt valuations, and you could argue there is even a slight cut priced in” to the BOE’s key rate, Owen Murfin, a money manager at BlackRock Inc., said at a briefing in London. “The Bank of England isn’t expected to raise rates until 2018 despite having an underlying economy that is fairly robust.”

Murfin said the probability of Brexit “has been priced in to a certain amount in gilts so if there is a ‘Remain’ outcome you would have thought the initial outcome might be to price the Bank of England closer to the Federal Reserve.”

The yield difference between 10-year gilts and similar-maturity U.S. Treasuries was little changed at 43 basis points. U.S. yields were 48 basis points higher in March, the most since 2006.

Risk for Clients

“I don’t think with an uncertain outcome you’d be warranting too much risk for your clients in terms of Brexit,” BlackRock’s Murfin said. “I’ve been taking down some risk now; there might be a little bit too much complacency” in markets.

U.K. sovereign debt has returned 7.6 percent this year, outperforming almost all other developed markets. Globally the average yield of government debt has hit new lows amid central bank policies that include quantitative easing and the introduction of negative interest rates. Billionaire investor and Facebook Inc. board member Peter Thiel said Wednesday that government bond yields and negative interest rates are signs of an asset bubble.

Linker Sale

The Debt Management Office auctioned 900 million pounds of index-linked debt due in 2036, in its last sale before the referendum. The 0.125 percent securities were sold with a real yield of minus 0.974 percent.

The 10-year yield could fall further to 1 percent in the event of Brexit, according to Daniela Russell, a portfolio construction associate at Legal & General Group Plc in London. She said new lows may be seen in the coming months.

“The broad global macro backdrop has softened again,” Russell said. “So even if the market feels some relief after a vote to remain, we are going to have to wait several months for it to become clear whether the recent weakness in the U.K. data is just Brexit-uncertainty-related.”

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