The 10Y gilt yield has hit its highest level since 2008, and whilst the near-term focus remains on oil prices and politics, the Bank of England’s balance sheet unwind poses further upside risk. And with the discussion about quantitative tightening (QT) flaring up again in the US under new Fed leadership, markets can learn from the potential impact on US rates by looking at the UK.
Sterling rates are relatively sensitive to global market moves, and the spillovers from the US term premium play an especially important role. Between 2023 and today, the correlation of weekly changes in the 2s10s of the GBP curve and the US curve has been a significant 0.6. If we take the 2s10s term spread as a rough proxy of the term premium, both seem to be similar at first sight. The market optimism in US equity markets helps the US curve steepen again and also adds to the upward pressure on gilt yields.
Japan’s curve shows a very different picture, and therefore we cannot simply assume a single global factor explains all term premia. For one, Japan’s economy has followed a very different path compared to other countries, experiencing stagflation for prolonged periods of time. Second, and of more importance to our analysis, is the fact that the Bank of Japan has intervened significantly more in the rates market through balance sheet policy than other central banks.