Politics and Fixed Income, a surprisingly volatile combination

On October 24th, Rishi Sunak won the bid for leadership of Britain’s Conservative Party and secured his role as the country’s next Prime Minister. Having steered the British economy throughout the pandemic, he is seen by lawmakers and investors as having steady and safe hands, amid an energy crisis and looming recession. 
Following the market chaos that erupted during the previous Prime minister’s short tenure, investors are looking toward new leadership to calm the GILT market, stabilize the pound, and bring stability to one of Europe’s largest financial markets.
The GILT market reacted positively to the developments, with yields falling between 24 and 32 basis points across the range of maturities on Monday, signaling a sense of safety is slowly being priced in. The iShares Core UK Gilts ETF also showed signs of life, closing at its highest level in the past month. The ETF has faired slightly better than its North American counterpart, the iShares Core U.S treasury Bond ETF on a monthly basis but is underperforming YTD by 8%.
The British pound also reacted positively to the news initially, but leveled off by mid-day Monday, and was up 0.05% against the USD at $1.1301, down from an overnight high above $1.14. As of Tuesday, October 25th, the GBP is back above $1.14USD as the foreign currency markets digest the news and the implications of Sunak’s appointment. 
Rate hikes expected in Canada
Across the pond, the Bank of Canada is preparing yet another steep interest rate hike on Wednesday, with investors and economists expecting an additional 75bps hike from the BoC despite recent observed weakness in the economy. Various Canadian bond ETFs such as the Vanguard Canadian Aggregate Bond Index ETF and BMO Aggregate Bond Index are down 15.32% YTD and close to 4% over the last month, as the BoC struggles to tame inflation and keep up with the FED’s own rate hiking cycle. 

Growing calls of a policy mistake from both public and private officials are seemingly not having any effect on the BoC’s hawkish stance, and investors will remain focused on the notes and conferences following the rate decision on Wednesday. 

A dove in hawk’s clothing?

Further South in the U.S, a surprising shift in tone is beginning to take place for some Fed officials. A recent report by the Wall Street Journal disclosed that certain policymakers discussed pausing interest rate hikes last week, reviving the hopes for a pivot that has proved elusive since the mid-summer market rally. Despite no clear indication of when the hikes may stop, the discussion seems to have revived investors’ hopes for a slowdown in the fastest hiking cycle of the last four decades, especially at a time when academic and high-profile asset managers have been warning of a grave policy error. 
Bond and equity markets alike relied on the hopes for more clarity on the Fed’s hiking path, with treasury ETFs across the maturity spectrum seeing a jump on Monday and Tuesday. The long-duration TLT ETF showed significant gains upwards of 2% on Tuesday, followed by 10-year treasuries which jumped 1.3% on Tuesday.

A softening of tone in official FED meeting notes would likely see a significant rally in both equity and fixed income assets, which have been punished mercilessly over the last 10 months. 

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