The U.K.'s Bond Selloff Could Spread to the U.S.

(Bloomberg) -- The front end of the U.K.’s yield curve hasn’t seen such a violent move in years. That selloff could yet make its way to the U.S. if money markets grow in conviction that the Federal Reserve may have to raise rates at a pace faster than previously thought.

The yield on two-year gilts has surged a phenomenal 65 basis points since the end of July as traders upended prior views that placed the Bank of England’s first rate increase in November next year. So much so that the monetary authority’s policy review Thursday -- earlier thought of as a do-nothing meeting -- is now considered live.

Yet the comparable part of the curve in the U.S. is sitting relatively smug even as money markets are pricing two rate increases by the end of next year, with the first one seen occurring as soon as the Fed is done with its bond purchase taper around the middle of 2022.

That means the two-year maturity is richly priced relative to where the Fed funds rate will be by the end of 2022, a margin of premium that is unsustainable and hence likely to be tested if markets grow in conviction about the pace of rate increases. Indeed, if the Fed’s famed “transitory” inflationary pressures prove not-so-fleeting and rates traders continue to raise the hurdle on breakeven rates, the two-year maturity may see a velocity of selloff not unlike what we have seen in the U.K.

While two-year Treasuries sold off the most since 2018 last month, there remains an astounding degree of complacency on rate hikes.

• NOTE: This was a post on Bloomberg’s Markets Live blog. The observations are those of the blogger and not intended as investment advice. For more markets analysis, go to MLIV.

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