UK government bond yields rose on Monday after Rachel Reeves was removed as Chancellor, with the market reaction intensifying as details of cabinet changes under new Prime Minister Andy Burnham emerged. The two-year gilt yield was up 8 bps, while the 10-year yield moved above 5% after climbing nearly 7 bps later in the session. UK bonds, equities and sterling fell together, and 10-year yields returned to their highest level since May, while the appointment of a new Chancellor remained unannounced.
Markets also responded to fresh fiscal proposals trailed within Burnham’s first 24 hours in office. Reports said he is weighing £24bn of spending and tax measures: £2bn linked to putting Thames Water into administration to keep it running through to 2027, £18bn to treat social care like NHS services by making it free at the point of use, and £4bn to increase the tax-free allowance, with further cost-of-living measures expected on Tuesday that could add billions more. Sterling weakened, with GBP/USD retreating from $1.35 and down by more than a quarter of one percent, while the Institute for Fiscal Studies said 10% of people in the UK pay 60% of all tax, alongside discussion of a potential 5% rise in the top rate.
Gilt Market Volatility and Fixed Income Trades
With UK 10-year yields surging past the critical 5% threshold following yesterday’s political shock, we expect severe volatility in the gilt market to persist. We recommend that derivative traders short UK gilt futures or purchase put options on debt, preparing for yields to climb even higher. Historically, during the 2022 fiscal crisis, unbacked spending plans drove yields up by over 100 basis points in days, a pattern that could easily repeat now.
Sterling, Equities, and Volatility Strategies
The British pound is facing intense downward pressure, having already slipped from its recent high of $1.35 on Monday. We advise buying put options on GBP/USD, targeting a swift move down toward the $1.30 level in the coming weeks. During the sterling crisis of September 2022, a sudden loss of fiscal confidence pushed the pound to an all-time low of $1.03, proving how quickly currency markets can capitulate.
The domestic UK economy is highly vulnerable to the proposed £24 billion spending plans and potential tax hikes. We suggest trading bearishly on the domestically focused FTSE 250 index through put options or index shorts. A potential 5% hike in the top tax rate could spark capital flight, depressing domestic businesses much more than global FTSE 100 firms.
Because the identity of the new Chancellor remains unconfirmed, we are facing a highly unpredictable trading environment. We recommend utilizing long volatility strategies, such as straddles on GBP/USD, to capture sharp market movements regardless of the direction. Implied volatility is currently underpricing the potential shock of a market-unfriendly appointment, making options relatively cheap.
