UK's 10-year gilt yield hovers below 1 pct mark with downside risk

The UK 10-year gilt yield has stabilised between Monday's record-low of 0.93 percent and the 1.00 percent mark on Wednesday, and will probably hover in this area (with risks on the downside) in the absence of further information about the country's post-referendum situation. Also, rallying crude oil prices and firm equities market limited the fall in bond yield.

The yield on the benchmark 10-year gilts rose 1 basis point to 0.972 percent, yield on super-long 30-year bonds fell 1 basis points to 1.798 percent and the yield on short-term 2-year note bounced 2-1/2 basis points to 0.215 percent by 09:40 GMT.

Even the country's CDS spread narrowed slightly about 46 basis points at 5 years and in any case, the wider credit premiums are dominated by fundamental factors. Specifically, up to 50 basis points of BoE rate cuts are getting priced in by year-end, and risk aversion will maintain demand for domestic safe haven assets.

The Gilt/Bund yield spread has widened back by a slight 3 basis points so far today to 108 basis points, but this is more likely due to an easing of market risk aversion generally.

Moreover, 71 percent of economists expect the UK economy to experience a recession during 2016 or 2017, following the EU referendum, according to a new Bloomberg poll of 35 respondents. 82 percent foresee BoE stimulus, 73 percent expecting a rate cut, 60 percent a QE expansion and 47 percent credit easing measures. This compares with the market placing a 55 percent chance on the BoE cutting rates by 25 basis points i.e. taking the Bank rate to +0.25 percent by August, based on OIS pricing.

On Tuesday, the UK finance minister Osborne said that it is crucial to provide fiscal stability and the UK is in prolonged period of economic adjustment. Said decisions on taxes, spending to come under new PM and absolutely going to have to cut spending and raise taxes.

He further added that he stands by decision to hold referendum and pro-Remain candidate can become PM, not backing any runners for the moment. Own role in next government depends on new leader, he said.

On Monday, the 10-year UK yield dropped through and settled about 5 basis points below the 1.00 percent mark for the first time, as flight to quality flows accelerated and BoE rate cuts get priced in. The central bank may well cut rates by 25 basis points in August.

The 10-year Gilt/Bund yield spread is meanwhile narrowing towards the 100 basis points mark for the first time since 2013. Considering that it went below zero in 2011 and 2009, the spread could easily come down further as the UK/EUR money-market spread of approximately +80 basis points gets whittled down. The 2-year UK yield has now dropped to a 4-year low in the mid-teens but could potentially hit single digits.

The UK's rating downgrades from S&P's and Fitch didn't have any effect, as the moves were surprising only by their speed. The S&P an American financial services company late Monday downgraded the UK's credit rating following its ‘Brexit’ vote by two notices from AAA to AA, with a negative outlook.

The Fitch rating agency also made a one-notch downgrade to AA from AA+, again with a negative outlook. The latter agency referred to the negative impact of leaving the EU on the UK's economy, public finances and political continuity.

It said the uncertainty will induce an 'abrupt slowdown' in short-term GDP growth and cut its GDP forecast to 1.6 percent for this year, from the previous forecast of 1.9 percent and to 0.9 percent in 2017, from earlier forecast of 2%. The S&P slashed its GDP forecast for 2016-19 to 1.1 percent per year from previous 2.1 percent.

Interestingly, Moody's has not changed its UK rating of Aa1. These downgrades are no surprise due to previous warnings about such an eventuality.

Lastly, crude oil prices rose as investors took advantage of a two-day slide in crude following Britain's vote to leave the European Union to lock in lower prices. A looming strike at several Norwegian oil and gas fields threatened to cut output in western Europe's biggest producer, also helped support prices on Tuesday.

The International benchmark Brent futures rose 1.06 percent to $49.81 and West Texas Intermediate (WTI) climbed 1.36 percent to $48.50. The FTSE 100 trading up 2.16 percent at 6,273 by 09:40 GMT.