Gilt yields are likely to stay low for another 12 months, according to JP Morgan – bad news for bond investors. This week 10-year gilt yields dropped to a record low at 0.6% following the Bank of England’s interest rate cut last Thursday.
Nick Gartside, co-manager of the JP Morgan Global Bond Opportunities fund predicted that gilt yields have even further to fall, thanks to the Bank of England’s stimulus package to reverse the weak economic data revealed following the UK’s vote to leave the European Union.
In response to the UK’s vote to leave the European Union, the Bank of England last week cut interest rate to 0.25%. Part of the stimulus plan also included an expansion of the asset purchase scheme for gilts of £60 billion, taking the total stock of these asset purchases to £435 billion since the first round of quantitative easing in 2012. The move has shifted the balance between supply and demand in the gilt market, leading to falling yields and a rise in gilt prices, Gartside explained.
Matthew Russell, fixed interest fund manager at M&G, pitched in saying that while the market expected the Bank of England to cut interest rates last Thursday, the asset purchase programme came as a surprise, driving gilt yields to an historical low.
Currency fluctuations add to the economy’s woes; Weak sterling will lead to higher costs of imported goods, which means higher taxes on consumers, leading to a “bad inflation”, Gartside added. He said that against that backdrop, government bonds “should go up in price”.
Will Interest Rates Go Below Zero?
Data revealed last week suggested the steepest decline in UK production since October 2012, leading some commentators to suggest this could be the beginning of an economic set-back.
While the Bank of England effectively gave "forward guidance” that interest rate will come down again and it will do more in the way of gilts and corporate bonds purchases later this year, Gartside argues that the Bank of England will keep interest rate above zero.
“If they reduce interest rate below zero, it will lead to a lot of unintended consequences, one of those it is that it can be damaging for the financial sector, particular to banks,” Gartside said.
Despite the Bank of England Governor Mark Caney emphasising his unwillingness to reduce interest rate below zero on Thursday, saying that it would happen “under no circumstances”, Russell said there is still a possibility.
“Carney said he is not a fan of negative interest rates, but he might have to change his mind in the future if there are more sign of weak economic growth in the UK,” said Russell. He added that what Carney said might be applicable in the short term but it does not mean that he will not do it in the future.
All Eyes on the Autumn Statement
It is still uncertain what the new Prime Minister Theresa May and the Chancellor Philip Hammond’s economic policies will be, but the Autumn Statement in November will be a key indicator.
“The Autumn Statement will be very interesting in terms of what the Government intends to do on the fiscal side, in terms of relaxing several commitments to the balance budget or cutting taxes,” Gartside said. He added that investors should look out for an increase on infrastructure spending.
Opportunities for Income Investors
An interest rate cut and quantitative easing benefits riskier assets, such as equities, while it weakens the country’s currency, said Morningstar fund analyst Ashis Dash. An interest rate cut typically pushes bond yields lower, which is good for bond holders as bond prices move up.
However, given the historically low yield levels currently, it also creates the problem of low income from a part of the portfolio which investors have traditionally seen as the more stable and lower volatility source of income, Dash warned.
Gartside and Russell both shared the view that lower rates are a good opportunity for bond investors from a total return perspective. Gartside suggested investors keen to find income look for higher government bond yields in Australia and the US, while Russell suggested investors consider inflation-link bonds.
Russell’s view is echoed by June flows data from Morningstar Direct, showing that inflation-linked bonds enjoyed over £1 billion inflows to date.
