Yields decline even as markets turn hawkish
May delivered a counterintuitive move in the UK: bond yields fell even as markets turned more hawkish on the policy path. That disconnect captures the current backdrop well: policy expectations remain elevated, but lower yields suggest investors are not fully embracing the hawkish repricing.
The UK continues to be beset by slowing growth and persistent inflation—and now faces the added complication of rising energy prices nudging expectations in a more hawkish direction.
As markets have moved from pricing cuts to contemplating hikes, yields have adjusted modestly, but credit spreads have remained impressively unmoved.
The domestic backdrop remains one of gradual pressure rather than sudden deterioration. Consumers are feeling the strain from higher prices and slowing real income growth, while activity indicators point to a loss of momentum rather than a collapse.
Bond markets rallied while turning hawkish
Inflation remains the more immediate concern. Price pressures, particularly via energy, have complicated what was expected to be a smoother disinflation path. As a result, markets have turned more hawkish, even if the central bank has not fully endorsed that shift.
Interestingly, that repricing has not translated into a simple “yields up” story. On the contrary, over the past month, the UK 2-year yield has declined by 14 bp (from 4.39% to 4.25%), while the 10-year yield has also fallen by 14 bp (from 4.97% to 4.83%), although both were higher by ~50+bp since the war began.
So despite more hawkish narratives, the market has actually seen a rally in bonds over May—proof that nothing is ever straightforward.
Policy rates themselves remain elevated, with the Bank Rate at 3.75% and front-end benchmarks such as Sterling Overnight Index Average (SONIA) sitting just below that level. The money market curve remains steep, even after the recent bond rally, reflecting expectations that the Monetary Policy Committee (MPC) may still need to tighten further.
Credit spreads remain unmoved
On the supply and credit side, conditions remain stable. Issuance continues, demand remains intact, and—perhaps most notably—credit spreads have not moved at all, despite the shifting macro outlook. Markets, it seems, are content to acknowledge macro risks without pricing them too aggressively in credit—for now.
Positioning remains cautious but engaged. Short-duration assets continue to offer attractive yield, and investors are favoring flexibility given the uncertain policy path.
The UK market is stuck in a familiar place: growth is slowing, inflation is lingering, and the policy outlook is unclear. Yields have drifted lower even as expectations have turned more hawkish, and spreads are refusing to participate in the drama.
For now, the takeaway is simple: policy is restrictive, the market has already done some of the tightening work, and clarity remains elusive, which, in the UK, is starting to feel like a structural feature rather than a temporary condition.