Shamil Gohil, portfolio manager, Fidelity Short Dated Corporate Bond and Fidelity MoneyBuilder Corporate Bond Fund
The UK Government's Spring budget announcement largely played out as expected, with the Chancellor replenishing fiscal headroom back to £9.9bn through a combination of cuts to welfare, the aid budget and cracking down on tax avoidance. Whilst this may provide some relief in the short term, we view this as a temporary fix that simply kicks the can down the road. Longer-term, budgetary challenges remain as higher interest rates and weaker growth persist.
The Gilt market saw some volatility, most notably with prices rallying immediately after the DMO's announcement that Gilt issuance would be slightly lower than expected. Issuance will also be skewed towards the shorter end of the curve, with long-dated gilts (15yrs plus) making up just 13% of the issuance, (down from 19.9% in the Autumn budget and the lowest since 1990), driven by a combination of the high borrowing costs and structural declining demand from UK pension schemes.
Overall, we retain a relatively cautious stance, given tight credit spreads and a challenging economic backdrop, alongside increased geopolitical uncertainty.
(Head)room for improvement?
£10bn is arguably not enough headroom compared to the roughly £1.5 trillion of spending planned and uncertainties ahead. As shown in Figure 1, the historical average headroom has been closer to £30bn but recent governments have run it tighter. A £20b number would have been more constructive for Gilts. Ultimately, the fiscal headroom is how the market quantifies and judges the Chancellor's credibility. Gilts probably remain in no man's land until the Autumn budget as we will likely to see some fiscal slippage and buffer erosion from now until then.
Figure 1: Forecasts for headroom against targets since 2010
Source: Fidelity International, OBR. March 2025
With Debt/GDP > 100% and rising, it is hard to get out of the doom loop with a stagnant economy. An ageing population is not helping so continued structural reforms are needed to boost productivity. There are also question marks on how the increase in defence spending will be funded. The impact of global tariffs is unknown and will likely erode any future surpluses (via lower GDP).
The recent lower CPI print is likely a temporary move lower but should be supportive for front end UK rates as it reaffirms the likelihood of a 25bps cut by the Bank of England in May. However, the UK may need to get accustomed to higher inflation and higher rates for the foreseeable future.
Implications for positioning:
In an increasingly risky environment, we retain a defensive stance in credit, looking for opportunities to increase in quality where we can and taking profit off the back of strong performance. We continue to favour the shorter end of the curve, where all in yields remain attractive and we are able to effectively de-risk the portfolios whilst maintaining carry.
Important information
This information is for investment professionals only and should not be relied upon by private investors. Past performance is not a reliable indicator of future returns. Investors should note that the views expressed may no longer be current and may have already been acted upon. The value of bonds is influenced by movements in interest rates and bond yields. If interest rates and so bond yields rise, bond prices tend to fall, and vice versa. The price of bonds with a longer lifetime until maturity is generally more sensitive to interest rate movements than those with a shorter lifetime to maturity. The risk of default is based on the issuers ability to make interest payments and to repay the loan at maturity. Default risk may therefore vary between government issuers as well as between different corporate issuers. Due to the greater possibility of default, an investment in a corporate bond is generally less secure than an investment in government bonds. Fidelity's range of fixed income funds can use financial derivative instruments for investment purposes, which may expose them to a higher degree of risk and can cause investments to experience larger than average price fluctuations. Reference in this document to specific securities should not be interpreted as a recommendation to buy or sell these securities and is only included for illustration purposes. Issued by FIL Pensions Management, authorised and regulated by the Financial Conduct Authority. Fidelity International, the Fidelity International logo and F symbol are trademarks of FIL Limited. FIPM: 8933
