Risk-averse income investors are waiting in hope for gilt yields to rise. UK Government bonds have been very low for nearly a decade – with the 10-year gilt yield hovering below 3% since the global financial crisis. Rewind a to 1997 and a 10-year gilt would pay out close to 7% and in 1990 the yield hit 9%. Today the 10-year pays out a paltry 1.02%.
But those investors hoping for respite any time soon should not hold their breath, according to financial professionals.
“Do we think the UK gilts yield will recover to 4.5%? No, we don’t. The world has changed and moved on. We can only look at the US government bonds for that,” said Laura Frost, investment director with M&G.
Since November 2015, the UK 10-year gilt yield has never been up above 2%. Last time it yielded more than 4% gilt yield was in 2008. Gilt yields even fell to 0.9% this week, ahead of the General Election today. With the inflation rising to 2.5%, gilts offer no real return to investors.
Gilt Yields and the General Election
Even if the outcome of today’s General Election turns out to be surprising – for example a hung parliament scenario, it will only push yields even lower, said Timothy Graf, head of macro strategy EMEA with State Street. This is because the uncertainty thrown up by a hung parliament scenario will drive more investors into safe-haven assets, such as gilts.
“You will get some repatriation back to the UK, but that is a low probability scenario. Similar to the Brexit case, people thought the vote to leave the European Union would be bad news for gilts, but actually gilts flew after that and I think that is because of that uncertainty. The base case scenario is a Conservatives majority win, which might not have a huge impact on the gilts market,” said Graf.
“It is hard to imagine a massive selloff of gilts. Gilt yields probably will not be at 2% by the end of the year.”
Pension Funds Demand Keeps Yields Low
Pension fund demand for gilts is one of the main reasons behind the low yield, a report by Morgan Stanley stated. In the bond market, the balance of demand and supply is a crucial factor affecting the bond price and the bond yield.
Last year pension funds’ gilts investments reached the highest level since 1963, according to a report published in March by the Office of National Statistics. The report said in 2016, the provisional estimate of net investment of pension fund in gilts was £31 billion, the highest recorded figure since the ONS begun its report series in 1963.
Foreign Investment Does Not Impact Yields
Data provided by M&G showed 30% of the gilt market is owned by the Bank of England, 30% of it is owned by institutional investors in the UK such as pension funds, and 22% is held by overseas investors.
“So potentially even gilt yields goes to zero, which is pretty extreme, you still have a very large market of domestic holders. So I am not sure foreign investors pulling out of the market would have a huge impact,” said M&G’s Frost.
A loosening of monetary policies in order to stimulate growth is a potential way to bring up gilt yields – however the Bank of England Governor Mark Carney has been very clear that he is not going do anything even if inflation rises even further.
“We are luckily enough in the UK to have another mechanism of monetary policy aside from interest rates and the quantitative easing – we have our currency. Sterling will go up and down, to make sure we remain competitive. We don’t have to mess around with interest rates, sterling will do it for us. I don’t think there will be any interest rate action between now and the of Carney’s term. I think sterling will do the work for us,” Frost added.
Look for Opportunities Elsewhere
State Street’s Graf believes there is very little reason to invest in UK fixed income unless investors are mandated to own them in their portfolios.
“As for existing gilts holders, gilts have been one of the best performing government bonds in the world, but the real worry is this outperformance of gilts has come to an end,” said Graf.
Graf suggested investors buying US government bonds yields instead. The US 10-year government bond yields at 2.4%.
For investors who wish to invest in UK-listed bonds, investment grade and high yield bonds remain competitive, yielding an average of 2.7% and 5% respectively. The US investment grade and high yield bonds yield 3.4% and 5.9%.
