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Gilt corner: Long-dated gilts are in cloud cuckoo land

Craig Inches, Head of Short Rates and Cash

9 October 2017

This week has been a quiet affair for gilt markets, with the main moves coming as a result of renewed coughing and spluttering from sterling, as a poor showing at the Conservative Party conference hit the currency. With some factions within the Tory party now in open rebellion, the fog of political risk has once again dampened the currency, raising fears of further price rises from this latest bout of weakness.

Currency-based inflation fears have been compounded by a sudden shrinkage in supply in the airline market, with the bankruptcy of Monarch and staffing troubles at Ryanair likely to lead to price increases there, along with a rise in break-evens during the week. But despite these pressures, long-dated gilts yields still look far too low. At the height of the deflationary pressures at the end of 2014, with a base rate of 0.5%, the yield available on 30-year gilts was 2.6%. Fast forward to the present and despite a yield curve which has been steepening this week with expectations of further long-dated supply, the yield on these 30-year bonds is sitting at just 1.9%. With growth of 1.5% on an annualised basis and inflation of 2.9%, UK government bond yields seem to be in cloud cuckoo land when superimposed against economic fundamentals.

In our UK government bond portfolios, we’ve been reducing our exposure to long-dated gilts and are looking to switch into overseas bonds, particularly at the long end of the curve, ahead of the upcoming long-dated syndication in the next few weeks.

Elsewhere in the world, bond markets are taking a more sensible approach towards this shift in global economic conditions. The factors and indicators that weigh on US inflation are picking up as well, despite some impact from a pair of hurricanes on US employment numbers on Friday’s jobs report. Strong purchasing by manufacturers and crucially for central banks, an increase in wage growth, has increased the levels of optimism surrounding the US economy.

The latter is particularly important for the Fed and other central bankers, who had fretted for a long while about the lack of a pick-up in wage growth, and this looks likely to crystallise expectations for a US interest rate hike in December.

Past performance is not a guide to future performance. 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.