Considering the volatile global landscape, can some stability be found in Gilts? Here, Insight Investment’s1 Dave Hooker, senior portfolio manager and lead on UK bond strategies, shares his outlook on Gilts.
Key points:
Although markets have calmed somewhat, the Gilt market has been grabbing headlines for all the wrong reasons over recent months, on growing concerns about the UK fiscal outlook. At one point, the yield on the 30-year Gilt surpassed 5.4%, reaching its highest level since the summer of 19982, as investors speculated that the government might breach its newly introduced fiscal rules.
Despite market concerns, Chancellor Rachael Reeves has emphasised her commitment to “stick to her fiscal rules at all times3”.
The surge in Gilt yields has attracted significant buying interest from both domestic and international investors who perceive that the market offers value once again. Long-dated Gilt yields have returned to the levels that were last seen before the global financial crisis and are within the range that has largely prevailed since the Bank of England was granted operational independence. According to data from the Bank of England, overseas investors made a record £102.3bn of net Gilt purchases in the calendar year 20244.
Anecdotal evidence suggests that retail investors have also been significant buyers of Gilts in recent months. This buying has been focused on the front end of the yield curve, taking advantage of the tax efficiency that low coupon Gilts offer. With Gilt yields now well above equity yields, Gilts are once again an attractive source of income.
With yields at such elevated levels, Insight Investment believes that Gilt markets may also attract inflows from investors seeking traditional diversification benefits. Bonds have historically played an important role for investors seeking to diversify equity risk, as bond prices tend to rise during economic downturns when equity markets generally decline. This negative correlation to equities can help to shield investors during sharp equity drawdowns.
Although highly rated corporate credit can offer similar attributes, the yield premium available for such investments is at historically low levels.
Looking ahead, Gilt markets are grappling with a sense of stagflation – a combination of strong inflationary pressures and weak growth. Coupled with concerns about the UK’s fiscal position, these factors have combined to keep Gilt yields elevated, despite the Bank of England reducing interest rates over the last six months.
However, it can be argued that markets now reflect a more realistic trajectory for both future interest rate cuts and growth, with the bad news now largely priced in. When combining the uncertain global backdrop and attractive valuations, Insight Investment believes an investment case can once again be made for Gilts.
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