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Market Update

The UK budget impact on the cost of debt – a week of volatility

November 1, 2021


Despite much of the UK budget decisions being leaked in advance of the Chancellor’s delivery, his announcements on borrowing forecasts and underlying growth assumptions sent the gilt and swap market into a tailspin. This short piece highlights some of the key movements and implications for UK borrowers.

Gilts market update

Following the budget announcement, the gilt market rallied substantially. This reflected lower borrowing forecasts from the OBR which led to sharp rises in gilt prices, particularly at longer-tenors. Investors had been expecting greater supply in the market pre-budget, but the improved fiscal outlook reduces the borrowing need. The government’s requirement for debt is predicted to drop by £34.7B this year alone, with £51.6B less needed in 2022.

Source: OBR

Source: Bloomberg

Source: Bloomberg

The rally was particularly strong in the medium-to-long end of the curve, and will increase the attractiveness of fixed rate private placement debt, increasingly deployed by real estate borrowers as a way to fund real estate investment. Yields on 20-year gilts fell by 19 bps while yields on the 30-year were down 22.5 bps to 1.087% at the time of writing. This has brought yields right back down to levels seen at the end of September, before recent sell offs.

The sharp drop in yields extended into the belly of curve where the 15-year gilt yield fell 12.0 bps to 1.168% with the 10-year gilt trimming 9.7 bps to end the day trading at 1.013%, their biggest one day drops since the current quantitative easing programme began.

At the short end of the curve the drops were less sharp, but their presence notable in an environment where short-term inflationary pressures continue to cause concern.

Source: Bloomberg

Stronger than expected growth is expected to drive increased inflation over the next 12 months. The OBR is now predicting GDP to return to pre-COVID levels by the end of this year, well ahead of their March forecasts (which didn’t expect this level to be crossed till Q1 2022). Combined with increases in energy prices in recent months, this may drive headline CPI to 4.4% by June 2022.

Source: OBR

Source: OBR

Source: Bloomberg

Lower rates and higher inflation have pushed real interest rates further into negative territory. The 30-year real yield is around its lowest level since 2016 at -2.02%. Should inflation spike further over the course of 2022 there is potential for this to drop lower still.

These inflationary concerns and market volatility also impacted the swap market, with the short end showing large increases in interest rates over the last month. Using the 3-year swap as a indication, the rate has moved from 0.599% to 1.072% in the space of one month. Cap premiums which are increasing also have the additional pricing impact of materially higher volatilities. A cap on £20M at a strike of 1.5% for 3 years was £75K a month ago, and today it is £192K.

Those borrowers with transactions to hedge in the last week have been faced with ever increasing funding costs; and that’s assuming their counterparty bank would even offer a price. We saw a few banks this week refuse to quote as they could not offset their own risk in such choppy conditions.

Chatham Rates can keep you up to date on these market movements, but as always if you would like something specific priced, or to understand more about what is driving these movements your Chatham relationship manager can help.

About the author


Chatham Hedging Advisors, LLC (CHA) is a subsidiary of Chatham Financial Corp. and provides hedge advisory, accounting and execution services related to swap transactions in the United States. CHA is registered with the Commodity Futures Trading Commission (CFTC) as a commodity trading advisor and is a member of the National Futures Association (NFA); however, neither the CFTC nor the NFA have passed upon the merits of participating in any advisory services offered by CHA. For further information, please visit

Transactions in over-the-counter derivatives (or “swaps”) have significant risks, including, but not limited to, substantial risk of loss. You should consult your own business, legal, tax and accounting advisers with respect to proposed swap transaction and you should refrain from entering into any swap transaction unless you have fully understood the terms and risks of the transaction, including the extent of your potential risk of loss. This material has been prepared by a sales or trading employee or agent of Chatham Hedging Advisors and could be deemed a solicitation for entering into a derivatives transaction. This material is not a research report prepared by Chatham Hedging Advisors. If you are not an experienced user of the derivatives markets, capable of making independent trading decisions, then you should not rely solely on this communication in making trading decisions. All rights reserved.