UK bonds ride out GDP revisions


Craig Inches, Head of Short Rates and Cash

25 May 2017

UK government bond yields have shrugged off the revision in UK GDP to carry on the same gentle downward course they’ve been following for most of this week, particularly in longer dated maturities. While much will be made of these growth figures coming in lower than previously forecast, the revised figure is no different to the 0.2% GDP growth in the first quarter of 2016, a world in which a 'remain' vote was still on the cards and equity markets were riding out a wobble in China.

The real change for bond investors has been the drop in the yield available on UK gilts compared to this time last year. But in a world where inflation is now above the Bank of England’s 2% target, equity markets are brushing all-time highs and central banks are beginning to discuss reigning in monetary policy and raising interest rates, yields should moving higher, not lower. While this highlights the degree of political risk, including the uncertainty around Brexit negotiations which markets are pricing in, government bonds now seem completely detached from economic fundamentals.

In addition, we see three other key trends shaping bond markets this week:

1. Oil prices boost inflation linked bonds
With almost no impact from this morning’s GDP data, the path for gilts has held fairly steady this week, rallying slightly this week with the yield curve moving a little flatter. In Europe, the yield curve has continued its steepening path, with bonds on the periphery in Italy and Spain outperforming this week. However, a sharp recovery in the oil price (and consequent increase in inflation expectations) has helped to boost index linked government bonds across the board. Real yields are down, with break-evens stronger this week.

2. Europe digests last week’s credit feast
In sterling credit we’ve seen little change in the direction of travel since last week, markets are firm and financials continue to outperform. Across the channel, European corporate bonds have seen a little weakness, particularly in longer dated debt, with the credit spreads on last week’s deluge of new issuance a little wider than when the bonds were originally offered. However, market demand for new credits remains robust, with a new deal from Eurotunnel seeing strong demand in both sterling and euros.

3. Emerging markets drag on high yield bonds
Performance in high yield bond markets has been relatively flat over the past week: developed markets' high yield bonds have been performing relatively well. However, there have also been a series of setbacks for more esoteric flavours of high yield debt. Continued political drama in Brazil has been joined by a downgrade in Chinese government debt that has spooked investors who hold Chinese high yield bonds further up the risk spectrum.

The value of investments and the income from them is not guaranteed and may go down as well as up and investors may not get back the amount originally invested. The views expressed are the author’s own and do not constitute investment advice.