Our views

Gilt corner: Is it the end of the world as we know it?


Paul Rayner, Head of Government Bonds

23 January 2018

US Treasuries made headlines this week as yields hit their highest levels since Donald Trump’s election. This psychological barrier is endemic of a wider trend in bond markets, and a signal to investors that this might be the end of the world as we know it for government bonds.
Strong demand for last week’s US inflation linked auction suggests that a renewed pickup in global inflation (which until now had come in fits and starts) could well be on the horizon. While central banks aren’t yet behind the curve, there’s no doubt that the good old days of seemingly limitless liquidity are coming to a close.
Despite the Bank of Canada’s attempts to stress their continued support for accommodative monetary policy (despite having just hiked interest rates once again), analysts are now forecasting the end of quantitative easing and lax monetary policy sooner, rather than later. As a result, we’ve been increasing our short duration positioning back up towards 0.6 of a year across our funds, adopting a defensive position against rising yields.
Within government bond markets, Brexit continues to weigh on gilt yields, leading to continued outperformance, while yield curves have been flattening. While we think this flattening might have been overdone for the moment, we maintain our view that gilt yields could rise further from here, and much faster than expected, especially should additional clarity emerge around the UK’s future relationship with the EU.
The next big event for UK investors is the upcoming syndication for 30-year index linked bonds on the 6 February. The choice of bookrunners might indicate slightly less anticipated demand than last November’s record order, as liability driven investment (LDI) buyers look to trim their purchases and this could lead to more weakness than usual as this new supply hits the market.
Therefore, heading into this this supply event, we’ve opted to deploy many of our usual tactical positions to take advantage of the market conditions its likely to generate. We’ve been selling breakevens, while also selectively trading UK linkers into their US and German equivalents.  

US Treasuries made headlines this week as yields hit their highest levels since Donald Trump’s election. This psychological barrier is endemic of a wider trend in bond markets, and a signal to investors that this might be the end of the world as we know it for government bonds.

Strong demand for last week’s US inflation linked auction suggests that a renewed pickup in global inflation (which until now had come in fits and starts) could well be on the horizon. While central banks aren’t yet behind the curve, there’s no doubt that the good old days of seemingly limitless liquidity are coming to a close.

Despite the Bank of Canada’s attempts to stress their continued support for accommodative monetary policy (despite having just hiked interest rates once again), analysts are now forecasting the end of quantitative easing and lax monetary policy sooner, rather than later. As a result, we’ve been increasing our short duration positioning back up towards 0.6 of a year across our funds, adopting a defensive position against rising yields.

Within government bond markets, Brexit continues to weigh on gilt yields, leading to continued outperformance, while yield curves have been flattening. While we think this flattening might have been overdone for the moment, we maintain our view that gilt yields could rise further from here, and much faster than expected, especially should additional clarity emerge around the UK’s future relationship with the EU.

The next big event for UK investors is the upcoming syndication for 30-year index linked bonds on the 6 February. The choice of bookrunners might indicate slightly less anticipated demand than last November’s record order, as liability driven investment (LDI) buyers look to trim their purchases and this could lead to more weakness than usual as this new supply hits the market.

Therefore, heading into this this supply event, we’ve opted to deploy many of our usual tactical positions to take advantage of the market conditions its likely to generate. We’ve been selling breakevens, while also selectively trading UK linkers into their US and German equivalents.  

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.