The turn in global market sentiment has surprised investors in U.K. government bonds, spurring a rally that sent the yields on shorter-date debt to an all-time low.
The rates on 2- and 5-year bonds broke below previous records set in recent weeks, with the drop in yields exceeding other havens such as German bunds and U.S. Treasuries.
Investors had built larger short bets in gilts than in other sovereign bonds during the recent risk-on mood in markets, forcing some to unwind these positions, said Peter Chatwell, head of multiasset strategy at Mizuho International.
The flight to havens reflects investor worries that lockdowns may return and economies reopened more slowly. New infections set daily records in Texas, Florida and California. Health leaders called on the U.K. to prepare for a possible second wave, while Australia recorded its largest spike in cases since April.
"The drop in gilt yields has echoed moves in other safe haven bond markets," said Howard Cunningham, fixed-income portfolio manager at Newton Investment Management. "It has in my view been triggered by a slight 'risk-off' tone over the past few days, due to concerns about the spread of (COVID-19) outside of the U.K."
The yield on 5-year bonds retreated as much as 4 basis points to -0.066% as of 12:50 p.m. BST, and the rate on 2-year debt dropped 2 basis points to -0.094%. The yield curve flattened as 30-year yields fell 6 basis points.
The previous bets on a steeper yield curve followed the Bank of England's surprise move last week to slow down the rate of bond purchases, at a time when other central banks are expanding their programs. The decision caused rates on the longest maturity bonds to rise the most.
"The BOE has instilled doubt about its commitment to QE in contrast to the Fed and ECB, to name only two," Antoine Bouvet, a rates strategist at ING Groep. "This means gilts volatility should be more elevated going forward, and we could also see some underperformance."
With growing worries that a second wave of the pandemic could slow the economic recovery, U.K. bond yields are also being depressed by the lingering specter of negative interest rates.
BOE officials haven't been able to rule out the unconventional policy, leading money markets to regularly price them in and out for next year. Cutting interest rates below zero would add fuel to the rally in gilts.