As the US federal government continues into its 29th day – currently the second-longest shutdown in its history – we are taking a look at how the ripples from the US lending market may spill into gilts and UK corporate borrowing.
At the time of writing, non-essential US government services have come to a halt, but critical functions like national security and debt payments continue. The situation is not unusual, this is the 22nd shutdown in the last 49 years, and markets are mostly viewing it as temporary political theatre rather than systemic risk. However, as global lending markets are interlinked, there has been some spillover with investors seeking out other government bonds.
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This is not the longest US government shutdown on record. The longest, at 35 days, took place between December 2018 and January 2019 during the previous Trump administration. For now, there is still operational continuity, that is, the Treasury Department remains fully funded through to mid-November thanks to extraordinary measures. It can pay interest on existing Treasuries on schedule, avoiding any default risk. However, about 15% of federal outlays such as certain payments are delayed, as are releases of key economic data, which could indirectly pressure fiscal planning.
Treasury yields have shown mild volatility, with the 10-year yield rising slightly to around 4.2% early in the shutdown because of the implied uncertainty. They have since stabilised and edged lower, to a larger extent because markets expect – with a 98% likelihood – that the Federal Reserve will cut interest rates by 25 basis points this week.
Bond prices may experience temporary swings, as measured by the MOVE Index (the bond world’s equivalent of the VIX Index), but impacts are usually short-lived and modest. The equity-bond correlations have held, with no major selloff.
What will this mean for gilts and the broader UK bond market?
While the impact on gilts so far has been muted, it is worth keeping in mind several factors: duration, issuance and data risk, spillover effects and policy reactions.
In terms of duration, longer-dated bonds such as 10-, 20- and 30-year maturities tend to be more sensitive to yield changes. In both Treasuries and gilt markets, these maturities may see more movement.
Regarding issuance, if the U.S. Treasury Department delays or changes issuance patterns because of the shutdown, it could shift global supply dynamics. Missing or delayed US economic data also reduces transparency, which tends to increase risk premia and prompt investors to demand higher yields.
A shock in US bonds could ripple across global bond markets. For example, if US yields spike, investors might reassess global “safe asset” valuations, including gilts. In addition, if the shutdown leads to a meaningful drop in economic growth, the Fed may react (although there is no evidence of that yet), which could in turn affect bond yields through shifting risk perception.
So far, there has been little market reaction to the shutdown. With the US earnings season in full swing, the S&P 500 hit an all-time high above 6900 while Euro Stoxx rose 2% on the month. Sanguine equity sentiment has been helping to further compress credit spreads, with the iTraxx XOVER index, a proxy for the cost of insuring European high yield debt, remaining tight at around 2.5-2.6%.
Sentiment on gilts remains broadly flat
Global risk sentiment in the sovereign credit markets has shifted slightly, with bonds outside the US seeing some safe haven buying amid US uncertainty. Ten-year gilt yields rose to 4.7% in early October, a multi-year high, driven mainly by UK-specific concerns, but have since eased notably. Last week, gilts strengthened while 5-year gilt yields declined to 3.946% from 4.05% and 10-year gilt yields fell to 4.478% from 4.595%, dampened by inflation data coming in below expectations at 3.8%, accompanied by signals that the Chancellor might impose national insurance on LLP-type companies such as law firms, accountants and GP practices.
European sovereigns have moved in the opposite direction, with yields across major European sovereigns rising during the week.
Overall sentiment on gilts remains broadly flat, with optimism around expected BoE rate cuts offsetting US headwinds. Pension funds and insurers are continuing to hold gilts steadily, with funding levels boosted by higher yields earlier in the year.
For the moment, the effect remains very mild. Nevertheless, a prolonged disruption in the US could heighten volatility in other sovereign markets.
