Gilts are poised to wake up from their lull

Bonds
Althea Spinozzi

Head of Fixed Income Strategy

Summary:  Bets for the Bank of England to increasingly become dovish might have run too far. Since summer, two-year Gilt yields have dropped the most compared to the US and European peers. Yet, UK inflation remains the most elevated among the G7, while the UK government provides fiscal stimulus. Within this environment, it is likely for Gilt yields to resume their rise towards 5% across the yield curve. We favor a barbell strategy looking to take exposure to the front part of the yield curve for safety and the long part for protection in case of a downturn.


Gilts will soon need to face the harsh reality: the Bank of England cannot afford to entertain a dovish stance.

Last week, the Office for Budget Responsibility had to revise the UK GDP forecasts for this year upwards to 0.6% from -0.2% in March. Yet, expectations for growth to remain flat in 2024 ignite bets that the Bank of England might need to step in to rescue the economy.

Yet, such bets might have run too far. From the beginning of July until today, two-year Gilt yields have dropped by 65bps, the most compared to German and US peers. Two-year yields are more closely linked to changes in monetary policies than other maturities. However, core inflation in the UK remains above 5%, services inflation is above 6%, and wages are still growing by almost 8% YoY. At the same time, current inflation rates in the US and Europe are more than a percentage point below the one in the UK, indicating that the job of the BOE is far from over.

To confirm such a notion, during last week's Autumn Statement, UK Chancellor Jeremy Hunt said that inflation is expected at 2.8% by the end of next year, suggesting that reverting to the 2% inflation target might take longer than anticipated.

Let’s not forget that despite a complacent bond market, with the freshly minted £21 billion stimulus package, the government is still easing the economy. Although UK elections are due on the 28th of January, 2025, it is clear that throughout 2024, major parties will be in full general election mode, and more fiscal cannot be excluded. That is likely to be a drag on what the BOE is trying to achieve and, ultimately, on Gilts.

Within this framework, it is unlikely that yields will continue to drop. As the bond markets reject expectations for rate cuts next year, yields will likely resume their rise across the yield curve.

The yield curve will likely remain inverted as markets contemplate what higher-for-longer monetary policies mean for the economy. Yet, long-term yields are poised to resume their rise, and 10-year Gilt yields are likely to test resistance again at 4.63%. If they break above this level, they will likely continue their rise towards 4.73%. However, if they fail to break above this level, they might drop further between the 3.62% and 3.87% levels.

Source: Bloomberg.

Gilts are considered a safe haven for sterling investors. Therefore, while providing a guaranteed return to one portfolio, they also provide protection during a market downturn. However, depending on the investment horizon and the duration of the Gilts, their risk-and-reward ratio may vary.

It's good to note that short-term Gilts bring minimal duration risk while maximizing yield. Assuming a one-year holding period, two-year Gilt yields need to rise by more than 200 basis points to provide a negative total return. As the BOE is unlikely to hike rates further, such a scenario remains unattainable. Yet, ultra-long duration instruments, such as the 30-year Gilts, represent a directional bet on rates. As the economy continues to cool while the BOE remains on hold, we favor a barbell strategy looking to take exposure to the front part of the yield curve for safety and the long part for protection in case of a downturn. 

Quarterly Outlook 2024 Q3

Sandcastle economics

01 / 05

  • Macro: Sandcastle economics

    Invest wisely in Q3 2024: Discover SaxoStrats' insights on navigating a stable yet fragile global economy.

    Read article
  • Bonds: What to do until inflation stabilises

    Discover strategies for managing bonds as US and European yields remain rangebound due to uncertain inflation and evolving monetary policies.

    Read article
  • Equities: Are we blowing bubbles again

    Explore key trends and opportunities in European equities and electrification theme as market dynamics echo 2021's rally.

    Read article
  • FX: Risk-on currencies to surge against havens

    Explore the outlook for USD, AUD, NZD, and EM carry trades as risk-on currencies are set to outperform in Q3 2024.

    Read article
  • Commodities: Energy and grains in focus as metals pause

    Energy and grains to shine as metals pause. Discover key trends and market drivers for commodities in Q3 2024.

    Read article
Disclaimer

The Saxo Group entities each provide execution-only service and access to Analysis permitting a person to view and/or use content available on or via the website is not intended to and does not change or expand on this. Such access and use are at all times subject to (i) The Terms of Use; (ii) Full Disclaimer; (iii) The Risk Warning; (iv) the Rules of Engagement and (v) Notices applying to Saxo News & Research and/or its content in addition (where relevant) to the terms governing the use of hyperlinks on the website of a member of the Saxo Group by which access to Saxo News & Research is gained. Such content is therefore provided as no more than information. In particular no advice is intended to be provided or to be relied on as provided nor endorsed by any Saxo Group entity; nor is it to be construed as solicitation or an incentive provided to subscribe for or sell or purchase any financial instrument. All trading or investments you make must be pursuant to your own unprompted and informed self-directed decision. As such no Saxo Group entity will have or be liable for any losses that you may sustain as a result of any investment decision made in reliance on information which is available on Saxo News & Research or as a result of the use of the Saxo News & Research. Orders given and trades effected are deemed intended to be given or effected for the account of the customer with the Saxo Group entity operating in the jurisdiction in which the customer resides and/or with whom the customer opened and maintains his/her trading account. Saxo News & Research does not contain (and should not be construed as containing) financial, investment, tax or trading advice or advice of any sort offered, recommended or endorsed by Saxo Group and should not be construed as a record of our trading prices, or as an offer, incentive or solicitation for the subscription, sale or purchase in any financial instrument. To the extent that any content is construed as investment research, you must note and accept that the content was not intended to and has not been prepared in accordance with legal requirements designed to promote the independence of investment research and as such, would be considered as a marketing communication under relevant laws.

Please read our disclaimers:
- Notification on Non-Independent Investment Research (https://www.home.saxo/legal/niird/notification)
- Full disclaimer (https://www.home.saxo/en-hk/legal/disclaimer/saxo-disclaimer)

None of the information contained here constitutes an offer to purchase or sell a financial instrument, or to make any investments. Saxo does not take into account your personal investment objectives or financial situation and makes no representation and assumes no liability as to the accuracy or completeness of the information nor for any loss arising from any investment made in reliance of this presentation. Any opinions made are subject to change and may be personal to the author. These may not necessarily reflect the opinion of Saxo or its affiliates.

Saxo Capital Markets HK Limited
19th Floor
Shanghai Commercial Bank Tower
12 Queen’s Road Central
Hong Kong

Contact Saxo

Select region

Hong Kong S.A.R
Hong Kong S.A.R

Saxo Capital Markets HK Limited (“Saxo”) is a company authorised and regulated by the Securities and Futures Commission of Hong Kong. Saxo holds a Type 1 Regulated Activity (Dealing in Securities); Type 2 Regulated Activity (Dealing in Futures Contract); Type 3 Regulated Activity (Leveraged Foreign Exchange Trading); Type 4 Regulated Activity (Advising on Securities) and Type 9 Regulated Activity (Asset Management) licenses (CE No. AVD061). Registered address: 19th Floor, Shanghai Commercial Bank Tower, 12 Queen’s Road Central, Hong Kong.

Trading in financial instruments carries various risks, and is not suitable for all investors. Please seek expert advice, and always ensure that you fully understand these risks before trading. Trading in leveraged products may result in your losses exceeding your initial deposits. Saxo does not provide financial advice, any information available on this website is ‘general’ in nature and for informational purposes only. Saxo does not take into account an individual’s needs, objectives or financial situation. Please click here to view the relevant risk disclosure statements.

The Saxo trading platform has received numerous awards and recognition. For details of these awards and information on awards visit www.home.saxo/en-hk/about-us/awards.

The information or the products and services referred to on this site may be accessed worldwide, however is only intended for distribution to and use by recipients located in countries where such use does not constitute a violation of applicable legislation or regulations. Products and services offered on this website are not directed at, or intended for distribution to or use by, any person or entity residing in the United States and Japan. Please click here to view our full disclaimer.

Apple, iPad and iPhone are trademarks of Apple Inc., registered in the US and other countries. AppStore is a service mark of Apple Inc. Android is a trademark of Google Inc.