Sterling Under Pressure as Bond Market Stress Intensifies

Sterling is once again feeling the strain from global bond market pressures, even without the extreme volatility witnessed in previous episodes. Long-dated yields are climbing across major economies, yield curves are steepening, and concerns over sovereign debt sustainability and persistent inflation are mounting. The UK’s gilt market is not immune: while thirty-year yields did not spike dramatically yesterday, they quietly reached levels not seen since 1998—a milestone that cannot be ignored by investors.

Pound Weakness Lags G10 Peers

Sterling has been particularly vulnerable amid this environment. GBP/USD recorded its sharpest single-day drop since April, slipping below 1.34 dollars, with minimal technical support until 1.32. Meanwhile, GBP/EUR fell below 1.15 euros, taking year-to-date losses to almost 5%.

Market moves rarely occur purely on new data. More often, they reflect the point at which long-standing risks can no longer be ignored. The UK’s combination of stagnant growth, persistent inflation, and a hawkish Bank of England has long left sterling exposed. Now, fiscal pressures are coming to the forefront.

The government faces an estimated £51 billion budget shortfall, heightening investor anxiety. Chancellor Rachel Reeves must balance calls for spending restraint against party pressures and the likelihood of tax rises in the autumn budget. These fiscal worries are contributing to rising long-end yields and amplifying sterling’s fragility.

Potential Relief on the Horizon

Some relief may come later this month. The Bank of England’s 18 September meeting is expected to review the pace of gilt sales. Governor Andrew Bailey has previously expressed concern about market liquidity and the steepening yield curve, suggesting that quantitative tightening could be slowed, particularly at the long end.

For the moment, however, the UK remains at the centre of global bond market stress. FX options show a flattening volatility skew, indicating traders are braced for further downside in the pound. Elevated realised volatility is keeping hedging costs high, reflecting the cautious stance around GBP.

Volatility Returns as Summer Ends

Market calm has dissipated, replaced by a repricing of risk that has been simmering for months. Long-term yields continue to grind higher, curves steepen, and investors are now confronting structural challenges including fiscal fragility, sticky inflation, and policy uncertainty.

Seasonal factors are also playing a role. With summer over and trading desks fully staffed again, liquidity has returned and market reactions have become more pronounced. Moves that were tolerated in August are now triggering defensive repositioning across asset classes.

The dollar’s recent bounce reflects weakness elsewhere rather than a strong flight into safe assets. The yen remains under pressure amid domestic political noise, while gold has lost momentum despite recent record levels. Options markets continue to indicate caution, with high demand for downside protection and elevated hedging costs.

Economic data adds complexity to the picture. The latest ISM manufacturing survey showed improving new orders but continued softness in employment. Should this trend persist, the Federal Reserve may have room to ease, although global headwinds could offset some of the effect.

All eyes are now on Friday’s payrolls report. A weak reading would support expectations of rate cuts, whereas stronger data could intensify political pressure on the Fed, adding further uncertainty to an already fragile backdrop.

Euro Faces Fiscal Challenges

The euro is also feeling the effects of global bond market stress, with rising long-term yields and fiscal concerns taking centre stage. France, in particular, has emerged as a focal point, with ten-year yields around 80 basis points higher than Germany’s ahead of an upcoming confidence vote. The widening spread highlights growing differentiation within the eurozone.

While political headlines last week did little to rattle the euro, yesterday’s bond sell-off served as a reminder that fiscal pressures are not limited to the UK. The initial FX reaction was broad, but longer-term impacts are expected to be more country-specific, as yield risk premia increasingly reflect local fundamentals.

EUR/USD briefly tested the lower end of its recent 1.16–1.17 range before paring losses following the mixed ISM survey in the US. Our central view is that stronger US labour market data later this week could push the pair below 1.16 in the short term, with US fundamentals dominating price action.

Negative sentiment towards the dollar has been difficult to sustain without fresh catalysts. The gap between spot EUR/USD and underlying rate differentials has narrowed compared with April and May, when the euro traded comfortably above 1.17 despite diverging fundamentals. Going forward, relative rate spreads will need to play a greater role if the euro is to challenge its July highs again.

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