Buy Long-Dated Gilts on Supply; Short Bonds Expensive, RBC Says

Investors should buy U.K. gilts with maturities longer than 10 years as their value is less “stretched” than short-dated bonds, and the “galloping pace” of debt issuance will support demand, Royal Bank of Canada said.

Shorter-dated gilts may be due for “a setback” in the near term after two-year gilt yields fell to a record low and 10-year yields dropped close to the level reached after the Bank of England announced its asset-purchase program in March last year, said Sam Hill, a fixed-income strategist at RBC in London.

The Bank of England said on Aug. 11 that inflation will be faster than previously forecast next year because of higher sales taxes, before falling below the bank’s target in 2012 as “persistent spare capacity weighs on companies’ costs and prices.” Inflation erodes the value of fixed-income securities.

“Investors will have to buy into a fairly bleak view of the U.K. economic outlook from here to think the current 10-year yield is a good return, especially after what the Bank of England said about the near-term inflation outlook,” Hill said in an interview. “Longer-dated gilts, in my view, are offering a better medium-term value.”

U.K. government bonds due between 2017 and 2020 returned 10.15 percent this year, while those with maturities of 10 years or longer gave investors 8.l5 percent, according to indexes compiled by the European Federation of Financial Analysts Societies and Bloomberg.

Long-dated bonds will also draw support from the Debt Management Office’s progress in selling gilts this year, Hills said. The agency, which plans to sell 165 billion pounds of securities in the fiscal year that ends March, has raised 85 billion pounds so far, according to Hill. Of the 40.4 billion pounds it plans to issue in long-dated securities, 20.2 billion pounds have been sold, he said.

“The DMO has raised 665 million pounds per day so far this fiscal year, and they only need to raise 337 million pounds per day for the rest of the year,” said Hill. “The implication is that supply is going to be much less of a constraint on the market, particularly the long end.”

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