Our views

Gilt corner: Policymakers stoke the inflationary fire, the figures offer little fury


Craig Inches, Head of Short Rates and Cash 

5 January 2018

The gilt market got off to a fairly sleepy start in the first week of 2018, but while the introduction of MiFID II has been credited with muting trading volumes slightly, the effect was far less pronounced than for the corporate bond market.
Yields moved only slightly across the board, after a gentle rally leading into the Christmas period. The most notable change was the slight outperformance of index-linked gilts and global inflation assets, buoyed by rising commodity prices and a range of comments from central bank policy makers around the world. 
Notes from the US Federal Reserve’s (Fed’s) latest minutes revealed that the tax plans passed in the US at the end of last year are likely to push inflation higher, leading the Fed to press on with plans for another three rate hikes for the next 12 months. 
The European Central Bank, whose prodigious appetite for bonds has known few bounds in previous years and spent the latter half of the year adjusting markets to its 2018 crash diet, has seen executive board member Bernard Couere voice his support for a withdrawal of quantitative easing.
The exceptions to expectations of rising inflation have come from the latest inflation numbers themselves, along with a little disquiet from 30 year index-linked gilts. For the latter, with the Debt Management Office signalling a new supply of 30 year inflation linked bonds in the next few weeks, the curve is likely to weaken in this area. After the strength in December and with this event approaching, in our funds we’ve begun to selectively trade into cross-market positions including US TIPS.
For the former, Friday’s latest eurozone core and headline inflation numbers remained stubbornly soft, a sign that the much hoped for pickup in inflation still has some way to go. Encouraging this steady rise in prices, and a corresponding increase in wage growth, will be front and centre of policymakers minds as 2018 begins to unfold.

The gilt market got off to a fairly sleepy start in the first week of 2018, but while the introduction of MiFID II has been credited with muting trading volumes slightly, the effect was far less pronounced than for the corporate bond market.

Yields moved only slightly across the board, after a gentle rally leading into the Christmas period. The most notable change was the slight outperformance of index-linked gilts and global inflation assets, buoyed by rising commodity prices and a range of comments from central bank policy makers around the world. 

Notes from the US Federal Reserve’s (Fed’s) latest minutes revealed that the tax plans passed in the US at the end of last year are likely to push inflation higher, leading the Fed to press on with plans for another three rate hikes for the next 12 months. 

The European Central Bank, whose prodigious appetite for bonds has known few bounds in previous years and spent the latter half of the year adjusting markets to its 2018 crash diet, has seen executive board member Bernard Couere voice his support for a withdrawal of quantitative easing.

The exceptions to expectations of rising inflation have come from the latest inflation numbers themselves, along with a little disquiet from 30 year index-linked gilts. For the latter, with the Debt Management Office signalling a new supply of 30 year inflation linked bonds in the next few weeks, the curve is likely to weaken in this area. After the strength in December and with this event approaching, in our funds we’ve begun to selectively trade into cross-market positions including US TIPS.

For the former, Friday’s latest eurozone core and headline inflation numbers remained stubbornly soft, a sign that the much hoped for pickup in inflation still has some way to go. Encouraging this steady rise in prices, and a corresponding increase in wage growth, will be front and centre of policymakers minds as 2018 begins to unfold.

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.