Sterling is the most sensitive barometer of Brexit fears. The pound slumps each time it looks more likely that Britain may crash out of the European Union without a deal. At the same time, however, UK government bond prices strengthen because bleaker economic prospects mean higher interest rates are less likely. The clearest sign that investors have had enough of the United Kingdom would be when both weaken at the same time.
The UK currency and government bonds have tended to react to political turmoil by moving in opposite directions. Sterling fell nearly 2 percent against the dollar and euro on Thursday after a string of cabinet resignations cast doubt on the future of Prime Minister Theresa May and her Brexit divorce deal. Yet even as the pound suffered its worst day since October 2016, gilts rallied. The yield on 10-year UK government bonds fell more than 10 basis points, to as low as 1.35 percent.
Even more telling was that UK sovereign debt performed better than German and U.S. alternatives. That would not have been the case if investors had become wary of Britain altogether. The gap between the yield on gilts and German bunds narrowed by roughly 10 basis points on Thursday. Meanwhile 10-year U.S. government bonds yielded as much as 174 basis points more than comparable gilts – the widest difference since 1984....MORE