AUS
NZ
UK
CA
USA
IND
Highlights
UK bond yields are on the rise, with long-term rates increasing since May, yet the FTSE 100 shows resilience.
The composition of large-cap international companies within the FTSE 100 provides a buffer against UK-specific fiscal concerns.
Domestically exposed sectors like real estate and homebuilders remain vulnerable to rising long-term rates.
The recent rise in long-term UK bond yields has drawn attention, particularly with the backdrop of a relatively weak fiscal position in the UK. Despite the sharp increase in yields, the FTSE 100, a benchmark of large-cap international companies, has shown significant resilience when compared to more domestically exposed parts of the market, such as real estate and homebuilders.
As of early May, UK bond yields saw a notable uptick, reaching levels not seen in years. This movement in yields has taken place in the context of a widening fiscal deficit in the UK. The increase in yields follows a fiscal backdrop marked by a higher deficit, despite an increase in employer taxes. Analysts note that this has created a challenging environment, especially for domestically sensitive stocks.
Composition of the FTSE 100: Shielded from Domestic Pressures
The FTSE 100 index, which includes many large multinational companies, has been less affected by the rising UK yields due to its diverse exposure. The companies within the FTSE 100 are less vulnerable to specific fiscal issues in the UK, as many derive significant revenue from international markets. This provides a natural buffer against UK-centric financial challenges that might otherwise push up Gilt yields.
This global exposure gives the FTSE 100 an edge over other UK-focused indexes, such as the FTSE 250, which has a greater emphasis on domestic businesses. The international reach of FTSE 100 companies means that their earnings are often less sensitive to domestic fiscal fluctuations, making the index relatively insulated from sharp movements in UK bond yields.
Impact of Rising Rates on the FTSE 100’s Composition
Another reason for the FTSE 100's resilience lies in its composition as a value index. The FTSE 100 has fewer growth stocks that are sensitive to rising rates compared to indexes dominated by growth stocks. Growth stocks typically see their valuations affected more by changes in interest rates due to the impact on the discounted value of future earnings. With fewer of these long-duration growth stocks, the FTSE 100 is better positioned to weather the effects of increasing rates.
Furthermore, the impact of higher yields on pension funds could have a favorable effect on certain companies within the FTSE 100. For defined benefit pension funds, rising yields help reduce the present value of liabilities, which may benefit the sponsor companies in the index. This factor contributes to the FTSE 100's stability amid an environment of higher long-term rates.
Vulnerable Sectors to Rising Rates
While the FTSE 100 has remained relatively insulated, some sectors remain exposed to the rise in long-term bond yields. Domestically oriented sectors, particularly real estate and homebuilders, are more sensitive to changes in interest rates. The increased cost of borrowing, which typically accompanies rising yields, can put pressure on these sectors, as it affects both demand for housing and the broader real estate market.
The FTSE 100 itself, with its broader international exposure, may see less direct impact from these shifts. However, companies within the index that have a higher dependence on the UK housing market could still face challenges as rates rise.
