Policy Makers Parting Ways Drives U.S.-U.K. Yield Gap to Record

  • Fed moves toward tighter policy as BOE monitors Brexit impact
  • Futures signal a 49 percent chance of 2016 Fed rate hike

The extra yield investors earn for holding two-year U.S. Treasuries instead of U.K. government bonds climbed toward its highest level in at least 24 years as central banks in both nations indicated they may move monetary policy in opposite directions.

The yield gap signals that investors see the Federal Reserve moving closer to increasing interest rates this year while the Bank of England may consider cutting rates, in the second reduction since the U.K. voted to leave the European Union. Short-dated securities are more sensitive to the outlook for central-bank policy than longer-term bonds.

“In recent days markets have priced in a larger probability of another small cut in the bank rate in the U.K., whereas obviously the Fed made it clear last week they intend to hike rates by the end of the year,” said Martin van Vliet, an interest-rate strategist at ING Groep NV in Amsterdam. “This is just the divergence in monetary policy which is showing up in the two-year spread.”

The U.K. two-year gilt yield was little changed at 0.09 percent as of 4:38 p.m. London time. The price of the 1.25 percent security due in July 2018 was 102.105 percent of face value.

Widening Gap

Treasury two-year note yields rose one basis point, or 0.01 percentage point, to 0.75 percent, leaving the spread versus gilts at 66 basis points. The gap earlier climbed to 68.8 basis points, compared with 69.4 basis points on Sept. 22, its highest closing level since Bloomberg began compiling the data in 1992.

In its last meeting held Sept. 20-21, the Fed signaled a more measured pace for future policy moves even as Chair Janet Yellen agreed that the case for a rate boost had strengthened. The decision to hold rates this month drew dissent from three voting members of the Federal Open Market Committee. Fed fund futures project a 49 percent chance rates will be increased by the December gathering, according to data compiled by Bloomberg.

In comparison, BOE policy makers indicated in their meeting this month that there’s still a chance of a rate cut this year as they evaluate the longer-term fallout from the Brexit vote. Swaps pricing signaled about a one-in-4 chance of a rate cut in the U.K. by the December meeting.

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