Sunniva Kolostyak: 2025 started with a big spike in bond yields. So today I am joined by Evangelia Gkeka, our senior manager research analyst here at Morningstar, to unpack what happened during January.
Evangelia, thank you very much for being here. Let’s start with talking about how significant the moves were in the past month.
What’s Driving the Surge in UK Gilt Yields?
Evangelia Gkeka: Sure. Thank you. So what happened? UK and global government bonds experienced a significant selloff in the first half of January 2025, driving yields materially higher and increasing borrowing costs for the UK government. The 30-year gilt yields surged to its highest level since 1998, while the ten-year yield has climbed to levels not seen since the 2008 global financial crisis. Both maturities, ten-year and 30-year, experienced increases of more than 1% over the past year, a remarkable shift for what are typically considered to be stable government securities.
At the same time, the British pound also weakened and reached its lowest level against the US dollar since November 2023, as expectations of higher for longer interest rates in the US have strengthened the dollar. So, gilt yield levels peaked on Jan. 15, but subsequently normalized, essentially following the decline in yields in the US due to the lower than expected inflation figures that affected the yields across the globe.
Kolostyak: So what were the drivers behind this peak that happened on the 15th?
Gkeka: So the recent spike in the government bond yields can be explained by both international and domestic factors. On the international front, US markets have played a significant role. US government bond yields have surged since the Fed cut rates by 50 basis points in September 2020. For ten- and 30-year, US yields climbed by approximately 1%. This was in response to the Fed signaling in December that the pace of interest rate reductions in 2025 is expected to slow down because of inflationary pressures.
Now, on the domestic side, several structural issues have amplified pressures on UK government bonds. Market participants have expressed skepticism about UK government October 2024 budget and whether the combination of tax increases, additional government borrowing and increased government spending will boost growth and productivity. Inflation concerns have further complicated the outlook. Wage and service inflation remain sticky and utility bills are expected to rise. Other challenges include the UK’s, substantial government debt burden, the widening fiscal deficit and increasing borrowing costs, all against a backdrop of stagnating UK economic growth.
How Are Fund Managers Responding to Rising Gilt Yields?
Kolostyak: So if we move on to funds, how are managers navigating this sort of yield spike?
Gkeka: Sure. Among our rated funds, we’re seeing different approaches to UK government bond exposures, with some managers finding opportunity in the recent selloff, and others maintaining a more cautious stance.
For example, some sterling government bond funds maintain significant overweight positions, viewing current yields as attractive. Two examples include Allianz Gilt Yield and Royal London UK Government Bond. Allianz entered 2025 with a duration overweight of around one year against its benchmark, almost all of it coming from UK gilts. Royal London has adopted a similar stance, maintaining about one year duration overweight in gilts. They expect the Bank of England will be more aggressive in cutting rates compared to what the market is pricing now. Lower rates should provide a more supportive backdrop for gilts.
Now, if we look at, global flexible bond funds, approaches here vary from maintaining substantial gilt exposure to taking more defensive position. One example here, M&G Global Macro Bond, entered 2025 with a sterling duration position of close to one year, an overweight relative to its benchmark. While persistent inflation and recent tax raising measures have reduced the likelihood of rate cuts in the short term, the team expects the Bank of England to eventually ease monetary policy to avoid a recession.
Another global flexible bond fund is a Jupiter Strategic Bond and this one has taken a substantial position in UK government bonds, with around 2.3 years exposure to longer dated, longer dated securities. Despite recent market volatility, the team has maintained this positioning. Jupiter mentioned that the current movements in yields have been more orderly than during the mini budget crisis back in September 2022. This is, partly because of improved risk management practices among pension schemes, using LDI strategies.
In contrast, in another example, Artemis Strategic Bond has adopted a more defensive stance holding just 0.2 years in UK gilts. The team proactively reduced exposure at the beginning of the year in anticipation of first quarter supply increases. They expect increased government spending to move gilt yields higher as funding and servicing requirements grow.
Key Lessons for Bond Investors from January’s Market Movements
Kolostyak: So what should investors take away from this event?
Gkeka: So the key takeaway is that the majority of managers that we rate have kept the exposure to gilts despite the recent volatility. Their view is that the current level of government bond yield is very attractive for investors, with a long-term horizon providing positive real yields above inflation rates. However, active management remains crucial given the complex mix of economic uncertainty, geopolitical risks and potential policy shifts ahead. So for investors, it’s important to select managers that have proven their ability to successfully navigate volatile markets.
Kolostyak: Evangelia, thank you very much for joining. For Morningstar, I’m Sunniva Kolostyak.
Read the report: Spike in UK Government Bond Yields
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