UK 30-year bond yields have hit their highest point since 1998. This is due to growing worries about government debt and spending. Currently, UK borrowing costs are the highest in the G7 countries. While this may seem like a UK issue, rising long-term yields are a global trend, driven not only by government spending but also by central banks’ softer policies. Central banks are not focusing on controlling inflation, which affects bonds. In the UK, the Bank of England has been cutting interest rates despite having the highest inflation rate in the G7 and ongoing large deficits. This is creating strain in the bond market.

Higher Interest Rates As A Solution

Higher interest rates might unexpectedly solve this issue. Central banks may need to rethink their strategies and consider raising rates. For the UK, the current situation may be hard to reverse, and long-term rates might only drop through a tough recession that leads to contractionary policies. Increasing rates could lower long-term yields by predicting an economic slowdown, higher unemployment, and reduced inflation. This situation goes against central banks’ goal of a smooth landing, which they had hoped would allow inflation to decrease gradually. The only other option might be a sharp economic downturn. The UK’s 30-year gilt yield is now at 5.5%, a level not seen since 1998. This signals that the market is responding strongly. This comes shortly after last week’s news showed UK government borrowing forecasts went up by another £20 billion and inflation in August unexpectedly rose to 4.1%. The Bank of England’s rate cut in July, when inflation was still far above its target, is now seen as a major policy mistake. For derivatives traders, this suggests a time of ongoing volatility, especially in UK assets. We should think about buying volatility through options on the FTSE 100 index or on the pound. The market is reacting to a policy blunder, and the VFTSE index, which measures FTSE volatility, has surged from 18 to 25 in the last month, indicating more turbulence ahead.

Divergence In Central Bank Policies

The gap between a relaxed Bank of England and a more cautious US Federal Reserve makes shorting the pound an appealing option. Although the US 10-year Treasury yield has risen to 4.8%, the Fed has not hinted at rate cuts, which weakens the pound. We are preparing for the pound to retest the 1.18 level against the dollar, akin to the lows experienced during the market turmoil in 2022. The main idea is that only a harsh economic downturn can address this issue, suggesting we should brace for a recession to lower long-term yields. This leads us to consider trades that would benefit from economic hardship, like buying put options on UK banking and consumer-discretionary stocks. It may also be time to start anticipating aggressive rate cuts in the future, perhaps in late 2026, once the anticipated slowdown sets in. This situation is not solely a UK concern; it represents a broader global loss of faith in central banks’ commitment to combatting inflation. This is also why gold has surpassed $2,600 per ounce, as it serves as a safeguard against these policy choices. We see value in maintaining long positions in gold derivatives as a key part of our portfolio to protect against this widespread central bank complacency. Create your live VT Markets account and start trading now.

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