Our views

Gilt corner: the Bank risks looking rudderless on rates


Craig Inches, Head of Rates & Cash

1 May 2018

When you’ve got to go, you’ve got to go. But often, you should have gone a long time before you got to that stage. The Bank of England could learn a few lessons about this from the debacle surrounding the departure of former Home Secretary Amber Rudd.
After a (let’s be frank here) pretty shoddy looking GDP number for the first quarter of 2018, markets are now pricing in almost no chance of a hike at May’s Monetary Policy Committee (MPC) meeting. Unlike the former Home Secretary however, there were few excuses to be had in the data, with the ONS acknowledging that the poor weather conditions had little impact on the overall figures. 
It was just, at first glance, a weak quarter for the UK economy. After a string of earnings downgrades at domestically focused corporates matched by poor retail sales, the die had already been cast, though the numbers came in even lower than economists had forecast. However, it’s important to remember that this GDP number can be revised up (as well as down). Crucially for us as bond investors, those revisions won’t happen until after the MPC makes their decision in May.
If the finalised GDP data painted the economy in a more positive light, and the Bank chose to hold off, they’ll have missed their chance once again and be left looking rudderless (if you’ll pardon the pun) in their management of the UK economy. As the inflation numbers shrug off the last impacts of sterling’s devaluation and fall back towards the Bank’s target, they could be left wishing they’d hiked rates while they had the chance. 
While short-term gilt yields rallied last week and we sold some of the strength to move slightly underweight at the short end of the curve, away from the week by week drama the broader picture for UK government bonds is a little different. Long dated yields rose by around 15 bps during April, while short dated yields remained relatively unchanged on the month. 
The other big news for government bond investors last week came from the US, where 10 year treasury yields cemented themselves above 3%. Compared to what you get on the equivalent 10 year gilt, this looked attractive to us and we added to our treasury holdings off the back of this.
After a volatile quarter for markets, this poses an interesting question for investors and their allocation to risk assets. In the UK, the yield on the FTSE All-Share still offers a healthy premium above government bonds of almost any duration. 
But across the Atlantic, things have drifted away from the norms US markets have experienced since the financial crisis. When even one and two year treasuries are now yielding more than the S&P 500 (at market close last Thursday it was indicating a yield of just 1.96% for the forthcoming 12 months), some investors concerned about valuations might start to question whether they should swap some equities back into bonds.

When you’ve got to go, you’ve got to go. But often, you should have gone a long time before you got to that stage. The Bank of England could learn a few lessons about this from the debacle surrounding the departure of former Home Secretary Amber Rudd.

After a (let’s be frank here) pretty shoddy looking GDP number for the first quarter of 2018, markets are now pricing in almost no chance of a hike at May’s Monetary Policy Committee (MPC) meeting. Unlike the former Home Secretary however, there were few excuses to be had in the data, with the ONS acknowledging that the poor weather conditions had little impact on the overall figures. 

It was just, at first glance, a weak quarter for the UK economy. After a string of earnings downgrades at domestically focused corporates matched by poor retail sales, the die had already been cast, though the numbers came in even lower than economists had forecast. However, it’s important to remember that this GDP number can be revised up (as well as down). Crucially for us as bond investors, those revisions won’t happen until after the MPC makes their decision in May.

If the finalised GDP data painted the economy in a more positive light, and the Bank chose to hold off, they’ll have missed their chance once again and be left looking rudderless (if you’ll pardon the pun) in their management of the UK economy. As the inflation numbers shrug off the last impacts of sterling’s devaluation and fall back towards the Bank’s target, they could be left wishing they’d hiked rates while they had the chance. 

While short-term gilt yields rallied last week and we sold some of the strength to move slightly underweight at the short end of the curve, away from the week by week drama the broader picture for UK government bonds is a little different. Long dated yields rose by around 15 bps during April, while short dated yields remained relatively unchanged on the month. 

The other big news for government bond investors last week came from the US, where 10 year treasury yields cemented themselves above 3%. Compared to what you get on the equivalent 10 year gilt, this looked attractive to us and we added to our treasury holdings off the back of this.

After a volatile quarter for markets, this poses an interesting question for investors and their allocation to risk assets. In the UK, the yield on the FTSE All-Share still offers a healthy premium above government bonds of almost any duration. 

But across the Atlantic, things have drifted away from the norms US markets have experienced since the financial crisis. When even one and two year treasuries are now yielding more than the S&P 500 (at market close last Thursday it was indicating a yield of just 1.96% for the forthcoming 12 months), some investors concerned about valuations might start to question whether they should swap some equities back into bonds.

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.