Senior Fixed Income Strategist
Summary: There is more upside for Gilts in case of a hard Brexit, but if a deal is agreed upon tonight, we might see yields rising to test their upper trendline at 0.45%. The BoE will be wary of 10-year yields rising above 1% even if a deal with the European Union has been reached.
There is nothing romantic about a candlelit dinner with Boris Johnson and Ursula von der Leyen; however, this time around it may be the trick that will bring a Brexit deal together. In the past few days, it was clarified by several politicians that a hard Brexit is very much possible, as much as a deal it is. At the time of writing, cable is moving up, ending a three-day run of losses, and Gilts are also softer. Yet, a move down of 8bps in yields since the start of the week it is a significant move given that 10-year Gilts offer around 27bps in yield. Even though tonight Santa may bring along a Brexit deal, it is essential to note that considerable obstacles continue to be ahead of the British economy. Therefore the effect of good news might wane quickly and bring the market back to reality. As a matter of facts, the Covid-19 crisis inflicted deep scarring to the economy, which will take time to heal. The Bank of England knows it, and it is ready for more stimulus. Hence, only one outcome is possible: low Gilt yields for longer.
However, what does low mean in figure terms?
Since the beginning of August, we have witnessed to 10-year Gilt yields trading in an ascending channel. They have already tested the lower trendline three times, and if a hard Brexit comes around, they would most likely break it and move down to try the lowest yield ever recorded in history around 10bps.
At the same time, if tonight a Brexit deal is agreed upon we might see yields rising in the coming days and testing the upper resistance line at 45bps. However, we have to keep in mind that if a deal is reached, it doesn't mean it will be a good deal for the British economy. Hence, an element of a surprise amid the reaching of an agreement can still give a boost to Gilts. Regardless, there is more room for yields to rise rather than fall to historic low levels.
In November, the BoE maintained the bank rate at 0.1% but announced an extra 150 billion pounds of asset purchases to be carried out until the end of 2021. The news boosted Gilts but didn't manage to push yields down at such level to break the supporting trendline; hence the central bank failed to counter the rising in yields. Rising yields can be a problem for the British economy even if a Brexit deal has been forged for the simple reason that the economy is yet to recover from the Covid-19 pandemic shock. If yields rise, but the economic recovery lags, companies will see financing costs rising faster than revenues. Nevertheless, yields are currently so low that the BoE will most likely let them soar up to a certain level. I believe that the BoE's tolerance level is around 1% in 10-year yields, which also corresponds to the level that yields will need to hit in order to break their decennial descending trend line.
In conclusion, in case of a hard Brexit, we will see 10-year Gilt yields falling to test the 0.1% benchmark bank rate level. In case of a favourable Brexit deal, we will see yields moving up to try their 45bps descending resistance line. In this scenario, yields can move up to 1%, but not higher because the BoE will be wary of having them rising faster than the economy recovers from the Covid-19 pandemic.
How to Trade Gilts on the Saxo Platform
You can buy gilts outright or purchase various instruments that will give you exposure to these securities such as:
Bond. Long Bond(s)
With real rates being too positive, we see three scenarios: Opportunity to lock in rates at cycle high, government overreach to keep the economy afloat or a complete reset of the economy.
Steen Jakobsen,
Chief Investment Officer
Is a bond bull market ahead? Inflation still poses a risk for investors, but the moment for increasing duration to your portfolio may be approaching towards the end of the year, when central banks might be forced to cut interest rates.
Althea Spinozzi,
Senior Fixed Income Strategist
The furious rate hike cycle has brought gains in the US dollar, but with stagflation risks in Europe and the UK and weakness in the Chinese economy, USD may have more room to run. But a strong dollar could also have repercussions for US growth, emerging markets and commodity prices.
Charu Chanana,
Market Strategist
With the cost of capital rising painfully, stagflation fears are back, illuminating the fragile state of the green transformation, while giving a tailwind to nuclear power, and threatening the growth of AI-related stocks.
Peter Garnry,
Head of Equity Strategy
With supply tightness not only in energy but all commodities, the momentum in commodity prices may continue, pressuring central banks to lower real rates. That could be a good setup for precious metals, including gold, silver and potentially platinum as well.
Ole S. Hansen,
Head of Commodity Strategy
As the pandemic showed, even the US Treasury can experience seismic shifts. With the government increasing the pace of issuing bonds to support fiscal spending, the complex Treasury market and regulatory constraints could spark a liquidity event.
Redmond Wong,
Market Strategist
The tide has turned for bonds. Given the current yields, bonds have become an attractive investment, with added benefits including lower risk than stocks, increased diversification and a steady stream of income unaffected by economic changes.
Peter Siks,
Investment Coach
