Bond Traders Brace for New Gilts Selloff as Local Elections Loom

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(Bloomberg) — UK bond investors are shifting their focus from monetary policy to politics, with local elections next week seen as a potential catalyst for turmoil in government that could trigger a renewed selloff.

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Long-dated UK gilts — a key barometer of fiscal and political risk — are heading for their worst weekly performance in seven weeks, with 30-year yields up 12 basis points at 5.70%. That’s the highest yield of any major developed market.

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After taking a beating from rising inflation and expectations for interest rate hikes, the UK government bond market has been hit by political risk in recent weeks as Prime Minister Keir Starmer’s ill-fated appointment of Peter Mandelson as US ambassador came under renewed scrutiny. 

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Money managers at Aegon Asset Management and RBC BlueBay say big losses for Starmer’s Labour Party in local elections in England, and for national parliaments in Scotland and Wales, on May 7 could send long-dated yields even higher.

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“We’ve had it circled in the calendar from the beginning of the year,” said Colin Finlayson, portfolio manager at Aegon. “It feels like we’re entering a period of when — not if — there’s a challenge to Starmer’s leadership. But no one’s going to say anything until after next week.”

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Finlayson is short 10-year gilt futures against a long position in comparable Australian debt in Aegon’s absolute return fund. He says markets are too bearish on Australia, where the central bank has already resumed rate hikes, and are underpricing risks in the UK.

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The Labour Party is set to lose 1,850 seats in the local elections, according to analysis by an expert in UK local voting. It’s the biggest electoral test Starmer has faced since he won office in 2024 and investors are concerned that a heavy defeat could prompt a shift in leadership or policy that would worsen the UK’s fragile fiscal position.

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What Bloomberg Strategists Say

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“The prism through which a potential (Starmer) departure should be considered is the uncertainty and fiscal risk premium that would need to be embedded in UK assets. On Thursday, the UK 30-year yield near-enough matched its peak from last September — which was a multi-decade high — and any sign a less fiscally responsible candidate is making a move will likely to take them higher still.”

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— Adam Linton, macro strategist. For the full analysis, click here

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The outcome could act as a catalyst for change, “whether that is a change of Prime Minister, a change in policy with more of a lurch to the left, or the potential for some other senior members of the government to be almost like sacrificial lambs,” Finlayson added.

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With the Iran war still unresolved and oil prices trading near four-year highs, a new bout of political turmoil could stoke further market volatility. The surge in energy prices has weighed heavily on gilts, with swaps now implying almost three quarter-point hikes from the UK central bank this year, against expectations for cuts before the war started.