Yields surge and GBP risk rises as central banks get more hawkish

Week of June 30

Last week, we saw government bond yields rise sharply on both sides of the Atlantic, as comments from the European Central Bank (ECB) and the Bank of England (BoE) indicated that they may join the US Federal Reserve Bank in tightening monetary conditions sooner than expected. The 10-year German Bund and British Gilt benchmark yields gained 21 basis points and 22 basis points, respectively. The equivalent-maturity US Treasury was also dragged higher and ended the week up 16 basis points.

The bond market sell-off was triggered by ECB President Mario Draghi when he expressed his confidence that the bank’s policies were working by strengthening economic recovery and restoring inflationary pressures in the Eurozone at the ECB’s annual conference in Portugal on Tuesday. His remarks fueled expectations that the central bank might start tapering asset purchases as early as September this year.

Speaking at the same conference as Draghi, Bank of England Governor Mark Carney surprised markets on Wednesday when he announced that he would be prepared to remove some of the current monetary stimulus, if business investment and wage growth were to rise sufficiently in order to offset weaker consumption. This was in stark contrast to his remarks from the previous week, when he had stated that now was not the right time to raise rates. Carney’s comments sent British government bond yields higher across the entire maturity spectrum, as markets began to price in even earlier rate hikes.

Also driven by these bullish central bank comments, the euro and the pound each gained around 2% versus the USD. Short-horizon risk for the GBP/USD exchange rate increased by 0.36% compared with the previous Friday, ending the week at 9.66%. Sterling risk is now higher than that of the Japanese yen, which had been the most-risky developed currency for most of the last four months.

In Axioma’s global multi-asset class model portfolio, overall short-term risk remained almost unchanged at 3.51% despite a significant rise of 1.4 percentage points in both FX and interest rate factor return volatility. However, at the same time, we observed a reversal of the correlation of those two risk factor groups from positive to negative, meaning that the increases in standalone volatility mostly cancelled each other out.

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.