Our views

Gilt corner: risk returns to markets, but gilts seem immune


Craig Inches, Head of Rates and Cash

22 May 2018

Most people’s first birthdays are happy occasions, a chance for friends and family to celebrate an exciting 12 months. For investors who bought Argentina’s 100 year bond at issue 19th June 2017, not every development has been a welcome one, after a promising start the bond has plummeted in price. 
Some investors have been left nursing paper losses, as markets reassess the value in holding ultra-long debt from a serial defaulter, whose currency has been shedding its value no matter what the Argentine central bank throws at it. 
While the strength of the US dollar is stoking the flames further across emerging markets, this toxic cocktail is a largely Argentine creation. But a reassessment of sovereign risk is starting to rear its head across the globe. As investors digest the implications of Italy’s anti-establishment coalition, the countries bonds have been selling off and their spread above bunds has been increasing. Whisper it if you dare, but some semblance of risk premia might be returning to government bond markets!
At home however, we’re still in the throes of a market where the gilt curve bears little relation to economic fundamentals.
The main event in the gilt market last week was the issue of one of the UK’s longest ever maturity bond. The DMO sold £6 billion of bonds due to mature in 2071, and thanks to both this maturity and its relatively low 1.625% coupon, for now this is the longest ‘duration’ nominal bond ever in the UK market.
While the curve had steepened ahead of the issuance, at face value the demand looked incredibly strong, with investors placing orders of over £37 billion. After the bond was printed it has outperformed, and the curve has flattened considerably as a result.
Strong demand for long dated gilts is nothing new in the current market. But we’d question quite how strong the investor demand for a bond offering just an additional 0.5% of yield above the equivalent five year bond maturing in 2023. When you’re only getting an extra 0.01% per year to maturity, those not constrained by liability matching or a need to hug a benchmark might question whether other assets (sporting a considerably lower duration and maturity) offered them better value for money.  

Most people’s first birthdays are happy occasions, a chance for friends and family to celebrate an exciting 12 months. For investors who bought Argentina’s 100 year bond at issue 19th June 2017, not every development has been a welcome one, after a promising start the bond has plummeted in price.

Some investors have been left nursing paper losses, as markets reassess the value in holding ultra-long debt from a serial defaulter, whose currency has been shedding its value no matter what the Argentine central bank throws at it. 

While the strength of the US dollar is stoking the flames further across emerging markets, this toxic cocktail is a largely Argentine creation. But a reassessment of sovereign risk is starting to rear its head across the globe. As investors digest the implications of Italy’s anti-establishment coalition, the countries bonds have been selling off and their spread above bunds has been increasing. Whisper it if you dare, but some semblance of risk premia might be returning to government bond markets!

At home however, we’re still in the throes of a market where the gilt curve bears little relation to economic fundamentals.

The main event in the gilt market last week was the issue of one of the UK’s longest ever maturity bond. The DMO sold £6 billion of bonds due to mature in 2071, and thanks to both this maturity and its relatively low 1.625% coupon, for now this is the longest ‘duration’ nominal bond ever in the UK market.

While the curve had steepened ahead of the issuance, at face value the demand looked incredibly strong, with investors placing orders of over £37 billion. After the bond was printed it has outperformed, and the curve has flattened considerably as a result.

Strong demand for long dated gilts is nothing new in the current market. But we’d question quite how strong the investor demand for a bond offering just an additional 0.5% of yield above the equivalent five year bond maturing in 2023. When you’re only getting an extra 0.01% per year to maturity, those not constrained by liability matching or a need to hug a benchmark might question whether other assets (sporting a considerably lower duration and maturity) offered them better value for money.  

Past performance is no guide to the future. 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.