Mike Riddell, Portfolio manager, Fidelity Strategic Bond Fund
The gilt selloff in early January has inevitably grabbed the headlines, where a common conclusion is to point fingers at the government. But this would miss the point; this is mainly a global fixed income story, not just something limited to the UK. Gilt yields are broadly moving with US Treasuries, where 30-year gilt yields have risen by no more than 30-year US Treasuries have done over the past couple of months. And there has been a similar sized move even in long dated German government bonds in the last month.
That's not to say that the UK has been immune to pressure. Although there's not any sign of a UK crisis yet, a worrying recent development is that gilt yields have risen a little more than in other markets, at a time when sterling has sharply weakened. Normally currencies are driven by interest rate differentials, where higher gilt yields relative to other countries would be expected to support the pound. The combination of a weaker pound and higher relative gilt yields has eerie echoes of August-September 2022, and if this continues, could potentially be evidence of a buyer's strike or capital flight.
Chart 1: 2yr and 30yr Gilt yields have risen sharply with curve steepening
Source: Bloomberg, 09 January 2025
Chart 2: UK 30yr yields underperforming the US in recent days
Source: Bloomberg, 09 January 2025.
What's been interesting about the global bond market moves of the past few weeks is that this is an unusual ‘bear steepening' move, where longer dated bond yields have risen by more than short-dated yields. These moves are indicative of fixed income investors becoming increasingly concerned about fiscal largesse, and all the government bond supply that accompanies it. It's not about inflation concerns, where the market's medium term inflation expectations are little changed since the beginning of November. Investors are instead demanding a higher risk premium or ‘term premium' to compensate them for owning longer dated government bonds.
What does this mean for the UK?
The obvious implication of these moves is that it's now become a lot more expensive for everyone to refinance their debt. If this selloff continues, it's going to push deficits wider over the long term, which then risks a doom loop since deficits need to be funded by ever more sovereign issuance. But it's also bad news for corporate issuers, or for anyone who wants a fixed rate mortgage - a jump higher in the risk-free rate is a tightening of financial conditions, which will dent global economic growth. So, if sovereign borrowing costs continue to surge higher, then risk assets could start to come under substantial pressure.
However, positively for UK investors, the potential return from owning government bonds has just got a lot higher too. If you buy a 30-year UK government bond today and hold to maturity, then assuming no default of course, the total return over the life of the bond is almost 400%, representing an attractive return over the long term.
IMPORTANT INFORMATION
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