Shocks From Abroad

Catherine Mann from the Bank of England spoke in Washington, DC, about how US policies affect UK markets. She highlighted that the 10-year UK gilt is significantly influenced by events in the US. Mann explained that Quantitative Tightening (QT) might reduce some impacts of the Bank of England’s rate cuts on long-term bonds. For more information, you can read Mann’s full speech on the Bank of England’s website. Mann’s insights reveal that external shocks, particularly from the US, are still impacting UK markets. She explained that UK bond yields, especially long-term ones, respond more to decisions made in the US than to local announcements. This means that UK gilts are not completely shielded; they react in real-time to interest rate expectations set by the Federal Reserve and shifts in global demand for long-term debt. Mann also discussed QT, suggesting that asset sales from the Bank of England’s balance sheet could balance out the typical decline in long-term bond yields that usually follows rate cuts. This suggests that as monetary policy loosens, the expected drop in long-dated gilt yields may not be as significant. The balance sheet runoff could prevent yields from declining too quickly. This has immediate implications for trading in long-term bonds. We need to pay attention to both the rate decisions in London and the asset supply changes from the Bank of England’s QT schedule. These factors are pulling in different directions, and this tension will likely persist. Additionally, signs of strength in the US economy have already led to higher inflation expectations, keeping upward pressure on global yields.

Market Implications

Changes in sterling interest rate derivatives may not always reflect local demand or domestic inflation. Sometimes, the movements are driven by fund hedging strategies from Europe or the US—adjusting portfolios in response to overseas rate changes. Mann pointed out this dependency. This indirect exposure complicates the understanding of pricing dynamics when viewed only through a local lens. For now, it’s important to closely watch cross-market spreads, especially the gilt-Treasury basis at longer maturities. Mann suggests this might differ more than usual if QT effects remain strong here but ease elsewhere. Trades must be aware of this asymmetry to prevent misalignment with duration risk. We should also consider that policymakers might be less likely to cut rates aggressively if they think the balance sheet runoff is tightening conditions on its own. This means that rate forecasts could be too low if they assume the policy rate operates independently from asset purchases. Conversely, any indication that QT will slow down might bring long-term rates closer to pricing in those cuts, although the impact would depend on timing and communication. As volatility affects secondary outcomes, we need to consider liquidity conditions and reactions to global signals, rather than just local policies. Some usual correlations may not hold as strongly this summer. Timing these shifts will be crucial for interest rate strategies. Create your live VT Markets account and start trading now.

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