Market Mechanics: Gilt Shock Exposes Systemic Fragility
Gilts were back in the market’s crosshairs this week, as a sudden repricing in UK government bonds reignited concerns around fiscal credibility and underscored the shifting structural risk profile of duration assets.
The 10-year gilt yield jumped +16 basis points in a single session – the largest one-day move since the Liberation Day turmoil in April – while the 30-year yield surged +19 basis points to 5.4%. This sharp bear steepening rippled across assets: sterling slumped -0.80% against the US dollar (worst in G10), and the FTSE 250 dropped -1.3%, its biggest daily fall since April. The broad-based nature of the selloff was striking, with bonds, equities, and currency markets all hit simultaneously.
Market nerves were initially triggered by the incumbent Labour government’s U-turn on welfare cuts, compounding doubts after an earlier reversal on winter fuel payments. The perception that the government is unwilling (or unable) to deliver modest fiscal restraint was further amplified by speculation around Chancellor Reeves’ future, before a late clarification by Prime Minister Starmer offered partial reassurance. Still, the damage was done.
This latest episode is a live case study of the broader theme we’ve been highlighting:
• Don’t rely on old playbooks – the idea that government bonds are a safe haven is increasingly questionable.
• Structural regime shift – higher inflation uncertainty and fiscal stress mean bonds now exhibit greater volatility and unstable correlation with equities.
• Tail risks are real – negative scenarios where both bonds and equities fall together are no longer theoretical.
• Conventional fixed income ≠ effective diversification – relying solely on duration as a defensive lever is increasingly risky.
• Difference = diversification – adding exposures with genuinely different risk/return drivers is key to building robust portfolios.
From a policy perspective, the fiscal backdrop is problematic. The government entered the year with a razor-thin margin against its own fiscal rules, and since March that margin has vanished. Spending reversals, tariff measures, and weak growth have left little room to manoeuvre. Yet large tax increases are politically unpalatable, and further spending cuts are proving impossible to implement.
Unless growth rebounds sharply, the government will be forced to choose between:
• a further round of unpopular tax hikes,
• politically toxic spending cuts,
• or a softening of fiscal rules that risks triggering renewed market turmoil.
This tightrope walk will continue to expose gilts (and broader UK risk assets) to political and fiscal shocks, reinforcing the need to think differently about portfolio construction in a world where ‘safe’ assets aren’t always safe.
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