HSBC: Attractive yields but hard to access, UK government bonds are too volatile!

According to Zhitong Finance, Max Kettner, Chief Multi-Asset Strategist at HSBC, succinctly summed up the current predicament of the UK gilt market: ultra-high yields are tempting, yet the rapidly changing political storms make any medium- or long-term judgments seem powerless, and market volatility remains high. Kettner stated: "I would love to buy these bonds because, clearly, the long-term yields are very attractive on paper. But at present, the trading cycle for UK gilts is just half an hour."

On Wednesday, the UK bond market stabilized temporarily after two consecutive sessions of heavy sell-offs. The yield on the 10-year gilt was essentially flat around 5.08% that day, once reaching 5.135%, marking the highest since June 2008. The 30-year yield climbed 1 basis point to 5.77%, just a step away from Tuesday’s intraday high of 5.814%—a peak not seen in nearly 30 years since 1998.

However, the apparent calm fails to hide deeper structural cracks. In the previous two trading days, UK gilt yields surged nearly 20 basis points, with the 30-year yield jumping about 20 basis points within two days, pulling the psychological 6% threshold into the market's field of vision. Since the beginning of the year, the UK 10-year yield has risen by about 64 basis points—more than double the increase seen in US and German sovereign yields over the same period. Among major developed economies, the UK’s 10-year borrowing cost of 5.12% tops the list—by comparison, the stronger US economy sits at 4.45%, while Germany, perceived as a model of fiscal discipline, is only at 3.10%. The UK is paying a higher "credit premium" for its double vulnerability—both political and economic.

“Perfect Storm”

This is not a mere numbers game. In the eyes of bond market participants, the UK is experiencing a “perfect storm” woven by geopolitical conflict, inflation anxiety, and political turmoil—striking at the very logic of the “pricing anchor” that underpins the modern financial system.

The Pricing Dilemma of “Political Premium”

The immediate trigger for this bout of gilt volatility was the Labour Party’s "historic defeat" in local elections.

In the England local elections held on May 7th, the Labour Party won only 1,063 seats, a sharp loss of 1,486 compared to the previous election, losing control of several key local councils, while its traditional strongholds suffered major losses. The Reform Party emerged as the biggest winner with 1,453 seats, and the Green Party also took 577 seats. Upon announcement of the results, internal Labour Party pressure transmitted rapidly from political to market pricing dynamics.

As of May 12, more than 80 Labour Members of Parliament had publicly called for Keir Starmer’s resignation, and four government department parliamentary undersecretaries had resigned to force the issue: these included Miatta Fahnbulleh of the Housing Ministry, Jess Phillips of the Home Office, Alex Davies-Jones of the Justice Ministry, and Zubair Ahmed of the Health Ministry, with three of the four urging Starmer to announce a resignation timetable in their letters.

Even more unnerving for the market, Wes Streeting, long regarded as a potential challenger to Starmer and currently Health Secretary, has told allies he is ready to resign as early as tomorrow to launch a leadership bid. On the morning of May 13th, Streeting and Starmer held a “crisis talk” lasting only 16 minutes, which Downing Street downplayed as merely “having coffee,” but the market clearly did not interpret it as mere small talk.

The core logic worrying the market is both clear and harsh: were Starmer to step down, his likely successors would almost certainly pursue more relaxed fiscal policies. Gordon Shannon, partner at investment firm TwentyFour, points out that most of Starmer’s prospective successors—with perhaps the exception of Streeting—lean toward expanding borrowing. Should Greater Manchester Mayor Andy Burnham succeed him, an extra £50 billion of borrowing over five years is likely, a 12% boost over current plans.

“What the bond market is reacting to is not just the potential departure of Starmer—it’s also about who takes over, and the likelihood of a lengthy leadership battle resulting in even more fiscal promises the UK simply cannot afford,” observes Kathleen Brooks, Research Director at brokerage XTB.

According to DTCC’s prediction market platform Kalshi, traders believe there is about a 65% chance that Starmer will not remain Prime Minister beyond December 2026, indicating a high degree of certainty is already priced into this political transition scenario.

Inflation Ghost: From the Strait of Hormuz to UK Petrol Stations

If political chaos is the fuse sparking the gilt sell-off, persistently high oil prices serve as the deeper engine supplying fuel.

The effective shutdown of the Strait of Hormuz continues; this key waterway accounts for about 20% of global oil shipments and remains partly blocked. Since the US-Israel strikes on Iran at the end of February, international oil prices have surged approximately 50%. Brent crude remains firmly above $100 per barrel, and on Tuesday, prices jumped more than 3% in a single day on renewed pessimism over US-Iran peace talks.

HSBC, in a report on May 6th, raised its 2026 average Brent price forecast to $95 per barrel, citing the longer-than-anticipated effective closure of the Strait of Hormuz as the core reason. Their base case assumes shipping gradually resumes in mid-June, but even then, a longer disruption means greater inventory depletion, tougher post-war restocking, and higher residual risk premiums. In a pessimistic scenario—where a comprehensive agreement takes about six months and flows remain severely restricted—Brent’s 2026 average would hit $120, and $95 for 2027.

Several Wall Street banks have recently followed suit in raising oil price forecasts. Goldman Sachs has lifted its Brent forecast for Q4 to $90, Citi raised its Q2 Brent forecast to $110, and Barclays hiked its full-year 2026 estimate from $85 to $100, warning that if the current situation lasts to the end of May, 2026 futures should be repriced to $110.

For the UK, which is highly dependent on imported energy, the transmission effect of oil price shocks is particularly severe. In its April monetary policy report, the Bank of England revised CPI inflation expectations upward to 3.3%, an increase of 0.3 percentage points from the February report, and explicitly warned that energy price shocks could spread further through a second-round wage-price spiral. In the Bank’s three macro scenarios—developed based on energy prices and second-round effect intensity—the worst case, Scenario C, shows inflation peaking above 6% in early 2027 should energy spike sharply and the second-round effects intensify.

“UK oil prices have now reached their highest levels since the Iran conflict broke out, and the energy crisis is far from over,” analyzed Xinhua Finance. “Though the Bank of England has kept rates unchanged, they have made it clear that things could worsen. If the energy market doesn’t improve rapidly, the Bank could well raise rates further and keep them high for a long period.”

Fitch Ratings’ latest assessment shows that energy price shocks alone could push second-quarter UK inflation 1.4 percentage points above previous predictions, making a breach of 5% increasingly likely. Fitch also expects the UK government to issue about £250 billion in gilts in the 2026 fiscal year, with deficit pressure and inflation expectation reinforcing each other in a negative feedback loop.

Rate Hike Expectations and the “Yield Gap Trap”

Persistent inflation pressures are forcing the market to sharply re-evaluate the Bank of England's policy path.

At the end of April, the Bank’s Monetary Policy Committee kept rates unchanged at 3.75% by a vote of 8 to 1, with one member calling for a 25bp hike to 4%—Chief Economist Huw Pill being the sole hawkish dissenter. Internal divisions between hawks and doves have become apparent. The report also sent a hawkish wait-and-see message: the window for cuts this year is essentially closed, and if energy prices spike further or second-round effects emerge, hikes could resume as soon as July.

Currently, the market has fully priced in further tightening from the Bank of England this year. Traders are betting on almost three rate hikes by year-end, a slight pullback from about 72 basis points priced in on Tuesday to 66, but still a markedly hawkish range. RBC Wealth Management's head of fixed income, Rufaro Chiriseri, estimates that the 10-year gilt yield will be around 5% by year-end—close to current levels. She notes that changes in market structure and reduced demand from pension funds have made the gilt market more susceptible to price swings.

Invesco fund manager Alexandra Ivanova puts it more bluntly: "I need to remind investors to revisit 'Finance 101'—you need to think about what compensation you're getting: liquidity premium, political risk premium, term premium, inflation risk premium... In the case of UK gilts, I think every single element tends to be higher than anywhere else."

Kevin Thozet, a member of Carmignac's investment committee, is even more cautious. He points out that after the “mini-budget” crisis during Liz Truss’s brief tenure, investors have imposed a certain “so-called stupidity premium” on the UK—"and that may well be the environment we're now entering."

Yet even as rate hike expectations rise, the pound has failed to gain traditional “rate support.” On Tuesday, GBP/USD fell 0.7% to $1.351, while GBP/EUR fell 0.4% to 86.92 pence, both at the lowest levels since late April. UK equities are also under pressure, with the FTSE 100 down 0.5%, Barclays off 4%, and both NatWest and Lloyds each slipping more than 3%.

The lesson from the yen markets is right up front—Japanese authorities intervened with around $63.7 billion between late April and early May to support the yen, but with no material convergence in yield spreads, the intervention impact is already being eroded. The UK now faces a similar “yield gap trap”: gilt yields rise, increasing the "notional attractiveness" of sterling assets, but if the main cause for yield increases is fiscal credit deterioration and runaway inflation expectations rather than improving growth prospects, the exchange rate will struggle to find support and may weaken further due to capital outflows.

“Bond Vigilantes” Return and Redefining the Pricing Anchor

The recent gilt market turmoil inevitably recalls the “Truss shock” of September 2022—when the Truss government’s large-scale tax cuts sent 30-year gilt yields soaring by over 100 basis points in days, briefly breaking 5%. The pension system nearly collapsed, forcing the Bank of England into emergency bond purchases, and Truss herself was ousted after just 45 days as PM.

Now, 30-year yields are well above those levels, and the pension system’s leverage buffer is narrower than three years ago. Market strategists warn that while the UK bond market has not yet reached a “crisis moment,” risks are clearly on the rise. Should international oil prices keep rising, UK inflation rebound, and the fiscal deficit widen further, long-term gilt yields could climb even higher, making the UK once again one of the weakest links in global markets.

The return of “bond vigilantes” is redefining how UK assets are positioned in global capital allocations. For decades, UK gilts—gilt-edged bonds—were considered safe assets among sovereign bonds for their perceived “zero default risk,” with their yields providing the risk-free interest rate “anchor” for sterling-denominated assets in the global pricing system. Now, the foundation of this “pricing anchor” is being eroded as fiscal discipline weakens, political instability recurs, and inflation expectations become unanchored.

The warning from Saxo UK investor strategist Neil Wilson is particularly pointed. He notes that Starmer’s departure “seems inevitable,” and if Labour swings left, the “bond vigilantes” will react swiftly. “At a time when fiscal conditions are already weak, spiking energy prices push up inflation, and growth prospects are deteriorating, a leftward turn will trigger a fierce bond market backlash.” Wilson especially cited recent remarks from Tribune Group leader Louise Haigh, who called for resetting fiscal rules and extending borrowing maturities. “Recalibrating fiscal rules is not what the market wants to hear.”

Invesco’s Ivanova is even more categorical: even with gilts offering yields far above US and German government bonds, they are not attractive—because every premium element—liquidity, political, term, inflation—"tends to be higher than anywhere else." In other words, investors are demanding the UK pay a composite risk premium for its political and economic fragility, and the stacking of these premiums is fundamentally shaking the traditional status of gilts as the “risk-free pricing anchor.”

Global Linkage: When the “Anchor’s” Sway Is No Longer a Local Phenomenon

The turmoil in the UK gilt market is not an isolated event. Recently, long-term yields in major global economies are rising in sync: US 30-year Treasury yields are approaching 5% again, Japan’s 10-year yield is around 2.5%, and Germany’s 10-year has climbed from negative territory in 2019 to about 3.0%. Long-term rates in the US, UK, Germany, and Japan are moving in tandem, reshaping the global pricing framework.

During this cross-asset shift, the most crucial variable is the sharp jump in US Treasury yields. As the “anchor of global asset pricing,” the US 10-year yield deeply influences global borrowing costs, from mortgages and corporate loans to sovereign debt—a shift of just one basis point in US yields triggers a global repricing of assets. And right now, this “anchor” is swinging violently.

Looking at the latest market moves, yields on all lengths of Treasuries are surging. The 30-year Treasury briefly broke past 5%, the first long-duration bond to do so. The 5-year is holding above 4%, the 2-year climbed to 4%, and the 10-year broke through 4.5%. Even more poignant, driven by expectations for energy cost surges due to the Iran conflict, the 10-year yield touched nearly 5%—a landmark level last seen in 2007.

For more than a decade, global markets operated in a low-rate environment and high-valuation tech stocks enjoyed sustained support. But as long-term yields rise, the present value of future cash flows falls, sharply increasing valuation pressures on tech stocks—especially the artificial intelligence sector. The ongoing gyrations in the UK gilt market—pivotal to the global “pricing anchor” system—are spreading to broader asset categories: spillovers are evident in the sterling exchange rate, UK bank stocks, and European bond markets, with chain reactions continuing to ferment.

Kelsey Berro, fixed income portfolio manager at J.P. Morgan Asset Management, captured the essence of the paradigm shift: “The market is effectively repricing the reality that ‘higher energy prices will keep inflation elevated for longer.’” For the UK, add to that persistent political uncertainty—gilts’ “risk premium” is far from being fully priced in.

Conclusion

Returning to Kettner’s “half-hour trading cycle” remark—it’s not just an investor’s dilemma but a reflection of the deep trust crisis confronting the UK gilt market. When political fortunes swing in a 16-minute meeting, when yields jump 20 basis points in two trading sessions, when 30-year borrowing costs approach their highest since 1998, the traditional “buy and hold” strategy has simply ceased to work.

What’s more thought-provoking is the weakening logic of the pricing anchor. UK gilts were once considered one of the oldest safe assets globally. Now, compounding risk premiums—political, inflation, liquidity, and term—are transforming gilts from “risk-free anchor” to “composite risk asset.” The profound impact on global asset pricing—from pension allocations to bank balance sheets, from sterling to European bond markets—may be only just beginning to emerge.

As RBC’s Chiriseri noted, changes in market structure and declining pension fund demand are making the UK gilt market more vulnerable to price swings. When traditional “stable holders” systematically exit and new marginal buyers demand higher risk premiums, the reconstruction of the pricing anchor is no longer a theoretical question but a market reality.