Short-term bonds provide shelter until the BOE is forced to make a U-turn.
While everything is set in motion for a bear steepening of the yield curve, it’s fair to highlight that such a move can quickly switch into a bull steepening in the event of a tail event or deep recession, which will steer the BOE away from its “higher-for-longer” stance. However, until such a scenario doesn’t materialize, we remain cautious and prefer the front part of the yield curve over a long duration.
Two-year Gilts still offer one of the highest yields since the 2008 global financial crisis. They have a modified duration of 1.9%, hence offering flexibility to investors who may want to enter another position not far in the future.
Despite long-term yields being on the rise, it's crucial also to consider 10-year Gilts (GB00BMV7TC88) and look at them from a risk-reward perspective. Entering at 4.45% today and assuming a holding period of a year will provide a loss of -2.38% if yields rise by 100bps, but they will return 11.5% if yields drop by 100bps in the same period. While the safe haven will provide protection against a tail event, we are wary of adding more duration until the macroeconomic backdrop becomes clearer.
When looking for a pickup over Gilts, buy-to-hold investors may consider the investment grade corporate space, which is also offering one of the highest yields in more than a decade. Below is a list for inspiration purposes.