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It’s been an eventful week across financial markets amid a sell-off in government bonds, a decline in the value of the pound against the US dollar, and billions of pounds wiped off the value of UK medium-sized companies.
While this all sounds quite dramatic, there is no need to panic. There is a logical reason why we saw these movements, and it is common to see swings up and down among the value of shares, bonds and currencies.
Sometimes the swings get bigger, but this week might not be for the history books, despite the plethora of negative headlines.
Why is everyone talking about government bonds?
The cost to the UK government of borrowing money over three decades hit the highest rate in 27 years on 2 September at 5.72%. This is measured by the yield on the 30-year gilt, a type of bond issued by the UK government.
Gilt yields move in the opposite direction to gilt prices, so when yields rise it means that investors are selling the bonds. This trend has been happening in slow motion for some time, and it is being driven by investor concerns over the state of UK public finances and a lack of faith in chancellor Rachel Reeves’ plans.
Bond investors are also disgruntled at renewed inflationary pressures and tariffs. In the UK, interest rate cuts from the Bank of England have made no difference.
So, what do bond investors want? They sell gilts when they no longer believe the return adequately compensates them for the risk of lending money to the UK government. Eventually, we could see yields rise to a level that starts to attract buyers again.
This sell-off in government bonds isn’t restricted to the UK – it’s also happening in other parts of the world including the US which is heavily indebted and in France where the government is on the brink of collapse.
How do bonds work?
Governments (or companies) issue bonds to investors as way to borrow money. In exchange, they promise to pay a regular interest payment and return the face value of the bond after a specific length of time.
Bond buyers typically demand a higher return from longer-dated bonds than shorter-dated ones to compensate themselves for the increased scope for something to go wrong during the additional lifetime of the investment, such as changes in interest rates, higher inflation or, at worst, a default by the party that issued the bond.
What’s been happening in the UK stock market?
We saw a sell-off in UK shares on 2 September as negative headlines around government bonds caused investors to lose their nerve.
The FTSE 250 index fell by 2.2% in a day, which is a large movement in stock market terms. That wiped £6.4 billion off the value of the index, which is made up of medium sized companies including the likes of broadcaster ITV, Sports Direct retailer Frasers and housebuilder Bellway.
There is a greater proportion of companies exposed to the UK economy in the FTSE 250 than in the FTSE 100 where approximately three quarters of members generate earnings overseas.
If bond investors are worried about the state of UK public finances and whether big tax rises could crimp economic growth, then it is natural to expect some nervousness around the prospects for UK-facing companies.
It was telling that many of the biggest fallers during this negative day for the FTSE 250 included companies heavily dependent on consumer spending, such as pubs group Wetherspoon and grocer Ocado.
The FTSE 100 ‘only’ fell by 0.9% on 2 September, cushioned by currency movements. The pound fell against the US dollar and that had a translatory benefit for the big group of stocks who earn overseas, and which have share prices denominated in pounds.
While talk of ‘sell-offs’ sounds a bit alarming, it is important to note that markets stabilised the following day and we saw a pullback in gilt yields, sterling picked up, and both the FTSE 100 and FTSE 250 moved higher.
Investing is never straightforward, and it can pay to stay abreast of events, so you understand why markets are moving in a particular way. However, there will always be something going on in the world so don’t fret about every single piece of news. Investing is a long-term game, and patience should hopefully pay off down the line.
Dan Coatsworth: Head of Markets
Dan Coatsworth is AJ Bell's Head of Markets. Dan has been with the company since December 2012 and has more than 18 years' experience in the industry, following the markets and all things investing. He...
