Gilt yields fall after surprise election result; Pound down, FTSE up in familiar pattern

Week of June 9

Last week, we saw British Gilts outperform their US and German counterparts, as the general election on Thursday, June 8, resulted in a so-called “hung” parliament. Markets seemed to have been caught off-guard by the failure of Prime Minister Theresa May’s Conservative Party to achieve an overall majority, despite numerous opinion polls pointing to this possibility in the weeks ahead of the actual vote. In reaction, the 10-year benchmark rate fell by 4 basis points during Friday’s trading. US Treasuries, on the other hand, were mostly unaffected, ending the week 4 basis points higher.

On Tuesday, government bond prices in the US and Eurozone rose, while gold and the yen gained 1% each, in anticipation of the heightened uncertainty later in the week. However, gains were more than offset by losses over the following days, so that both the yen and gold ended the week 0.2% and 0.7% lower, respectively.

The surprise outcome of the UK election also led to a significant drop in the value of the British pound. Within minutes of the publication of the first exit poll after voting had closed at 10 pm local time, the currency temporarily dropped by more than 2% versus the US dollar, but ended the day down only 1.6%. Compared with the previous Friday, losses were slightly less at 1.1%, due to gains earlier in the week.

In the now familiar pattern since the Brexit vote in June 2016, Friday’s trading saw the FTSE 100 index gain more than 1% on the argument that the blue-chip index consists mostly of internationally active companies that generate much of their earnings in currencies other than the pound.

In Axioma’s global multi-asset class model portfolio, short-term risk rose slightly to 4.25%, driven by a less negative correlation between equities and safe-haven assets, such as government bonds, the Japanese yen and gold. The upswing in overall volatility came despite a decrease in standalone standard deviations for all major risk factors in the portfolio. Assuming perfect correlation between all risk types, total portfolio risk would be 7.89%, resulting in a diversification effect of 3.64%. In the previous week, the latter number was higher at 4.28% due to a stronger negative relationship between equity and interest rate returns.

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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.