UK gilt yields may be ready to spike higher
13 November 2012 12:21am
IF UK government bond yields jumped rapidly, the UK could be plunged into a credit crisis that would make the last time look mild. Institutional investors would be lumbered with illiquid assets that they could not shift, paralysing money markets. The chances are slim; but previous crises have taught us to be prepared.
The UK has never defaulted on its debt. As John Pattulo of Henderson puts it: “The UK is AAA-rated, with a credible, independent central bank, that can print its own currency,” reducing the likelihood of bond investors losing money.
Helped by the Eurozone crisis, UK yields are at historic lows: the average yield on ten-year debt over the last 20 years was 5.23 per cent; today, it is around 1.70 per cent. Low rates and quantitative easing (QE) – which focused on buying government bonds – are the main drivers. The Bank was, until recently, the chief buyer, and now holds 26 per cent of all gilts issued.
Since the onset of the crisis, sterling has devalued by 20 per cent. “One way to get through a crisis is to have a currency that you can print and devalue,” says Pattulo, “making the UK more flexible”. Euro countries do not enjoy this flexibility.
“From a valuation perspective, gilts are expensive,” says Pattulo. The retail price index measure of inflation is 2.6 per cent. Investors are therefore receiving negative real yields, in effect paying the government to hold their money. And not only are gilts expensive, they are underperforming: the FTSE UK Gilts Total Returns Index has delivered 5 per cent in the last 12 months, compared to 9 per cent from the FTSE All-Share Total Return Index.
A marked improvement in the UK economy could trigger a rise in yields: “A sharp rise in inflation coupled with a rise in growth, hence the need for a rate rise” could lead to a spike in yields, says Pattulo. But this can only happen if the economy improves sufficiently.
Currently, central banks are unlikely to increase rates rapidly, and rates will remain low for some time, supporting a low-yield environment. David Curtin of BlackRock says that we’d need to see a repaired banking sector and household deleveraging before this happens. “This could be a long process, and we’re only about half-way through the adjustment.”
Positive news from the Eurozone has the potential to impact gilts. As the situation improves and money markets resume normality, money will move out of gilts putting upward pressure on yields.
There is also a possibility that markets will lose faith in the UK’s economic policy – as they did with Spain and Italy. But Pattulo believes that this could only happen if the Bank begins cancelling its holdings. Last week’s move to return interest earned on gilts back to the Treasury did not cause a violent reaction.
If yields were to rise sharply, the euro crisis has shown us a blueprint of how traders could position themselves: short bonds and banks; seek safety in US dollar, and potentially gold. But “protection of your capital becomes the priority,” warns Curtin.
Recent monetary policy has been designed to keep yields low, and there is speculation that more QE will come. Therefore, betting on a sharp correction is risky. If anything, yields will move up gradually, and only after the economy improves. That is the theory; but we have seen markets lose patience with theory before. It pays to be prepared.
In other news
A random combination of words and characters are automatically shutting down iPhone users' devices. [Read more]
London will play host to a record number of cyclists in August as the Prudential Ride London Freecycle event expands [Read more]
Commuters using London's Fenchurch Street could face a travel headache going home tonight, with operators confirming [Read more]
Eight candidates are vying for the role of deputy Labour leader in a crowded race alongside the high-profile leadership [Read more]
Between 1997 and 2013, people living in just four regions in the UK saw their disposable income increase when [Read more]
Swiss police are questioning 10 Fifa officials over the controversial award of the 2018 and 2022 World Cups to [Read more]
Dutch banking giant ING last night cut its stake in NN, an insurance and investment management company.
Update: Nearly 150 flights have been cancelled and 32 diverted to other European cities after a power outage shut [Read more]
A fresh investigation into migrant worker conditions in Qatar landed BBC reporters in prison recently. It is another [Read more]
The Bank of England will not back down on tough regulation, top official and ex-Barclays boss Martin Taylor said [Read more]
Perhaps the most enjoyable outcome of the General Election is the abuse now being heaped on the metropolitan liberal [Read more]
Private company SpaceX has received certified approval from the US to send military and spy satellites into space. [Read more]
Essex commuters will be the first to benefit from London’s Crossrail train service, with fare cuts of up to [Read more]
Boohoo’s finance chief Neil Catto was yesterday granted 1.6m share options worth £400,000 after his previous [Read more]
The FCA is considering whether to introduce new rules around PPI complaints following last year's ruling on the [Read more]
Politicians have been screaming for blood over the Libor scandal for years, as fines and firing have not sated [Read more]
The London-based tech startup notonthehighstreet.com has won a £6m loan from the Silicon Valley Bank.
Social media giant Twitter is in talks with Flipboard, to buy the media curation mobile app.
Charter Communications has finalised its $55bn (£36bn) takeover of Time Warner Cable. [Read more]