Bond yields fall and pound drops after surprise BoE vote

Week of August 4


Last week, we saw German government bonds outperformed their US and British peers, as risk-free yields fell on both sides of the Atlantic. The 10-year Bund rate ended the week 7 basis points lower, compared with a decline of 2 basis points each for the same-maturity Treasury and Gilt benchmarks. But the UK bellwether saw the biggest daily decline of 9 basis points to a 1-month low, when the Bank of England (BoE) once again surprised markets on Thursday. Recent comments from Monetary Policy Committee (MPC) members—including Governor Mark Carney himself—had caused a lot of speculation about a possible rate hike as early as last week’s meeting.

However, only two of the eight MPC rate setters actually voted to increase the base rate from its historic low of 0.25% to 0.50, down from three in favour of a hike at the last meeting in June. The decision followed an easing of consumer price inflation to 2.6% in June, after almost touching the BoE’s upper ceiling of 3% the month before. The Bank also lowered its GDP growth forecast for the current year to 1.7%, from a previous estimate of 1.9%.

Over the same period, the British pound fell by 0.6% against the US dollar, while its Japanese and continental European rivals closed near the levels of the previous Friday. Earlier in the week, sterling had risen to its highest level in almost a year, but traders seemed to be disappointed by the Bank of England’s decision to leave interest rates unchanged, and the exchange rate dropped by almost 1.5% during the last two days. At the same time, the two safe-haven currencies—CHF and JPY—saw their short-horizon risks decline by 0.13% and 0.10%, respectively, while the corresponding numbers for EUR and GBP remained almost unchanged.

Meanwhile, short-term risk in Axioma’s global multi-asset class model portfolio decreased by an additional 0.38% to 4.66%. The decline was caused by a mixture of lower share price volatility and a less positive correlation between FX and equity risk factors. This meant that US and non-US stocks seemed to move less in lockstep than in previous weeks, even though returns still pointed the same way most of the time. The impact was felt most in the US equity category, whose contribution to overall risk fell from 29% to 22%. The overall relationship between stock and bond returns remained positive, although it was less pronounced than in previous weeks.

Christoph Schon, CFA, CIPM

Christoph Schon is the Executive Director, Applied Research for EMEA at Axioma, where he generates insights into recent risk trends with a particular focus on fixed income and multi-asset class analysis. Christoph has been in the portfolio risk and performance analysis space for more than 10 years, having previously worked for Lehman Brothers/Barclays POINT and UBS Delta.