Curiously Strong

Gilts Are Due an Unfriending

With prices like these, you'd never guess at the pitfalls ahead.

March 13th. Mark the date because that is when the latest burst of the Bank of England's government bond purchases should end on this sceptred isle 1 . With such an unforgiving backdrop the death of the gilt market should shortly follow, but a whole raft of people seem not to be expecting that.

U.K. government bonds have lately been a haven for foreign investors diversifying away from rockier European markets, but their outperformance versus U.S treasuries is truly staggering. British yields are at a record low relative to their American counterparts, and that looks amazingly overstretched despite building expectations for a Federal Reserve rate increase as soon as this month.

February is the Kindest Month

Demand for safety from the trials of Europe pushed gilt yields lower

Source: Bloomberg

More to the point, gilts yields started their current extraordinary divergence from Treasuries when the Brexit vote prompted the restart of QE. As that program is now stopping, logically that should mean gilts revert back from whence they came, particularly since the prospects for faster inflation mean there's no realistic expectation that Governor Mark Carney will be minded to restart that emergency measure anytime soon.

Gilts Take an Unexpected Low Road

EU referendum helped push U.K. yields down to a record wide below Treasuries

Source: Bloomberg

And with the economy motoring along nicely, 10 year gilt yields down at 1.2 percent do not make a huge amount of sense. Ten-year breakevens, a measure of inflation expectations, are nearing 3 percent, so negative real yields of minus 1.8 percent are hardly attractive.

So there's little headroom for nasty surprises once Article 50 gets triggered this month. The end of the Brexit phony war of chatter and grandstanding, and the start of the real battle for a favorable divorce is unlikely to be particularly placid.

And market participants seem almost to have forgotten Chancellor of the Exchequer Philip Hammond's March 8 budget. It looks like it should be funding neutral, meaning that no significant new issuance should be needed to fund the government's plans. If there are no surprises, then gilt investors can likely shrug it off. If there are surprises that should weigh on bonds, investors will be in for some pain.

Reversal of Brexit Cut No Longer Priced In

February has seen the front end change its view on rates going back up

Source: Bloomberg

Gilts have rallied due to a nervous mindset that the economy could hit a Brexit wall, with corporate investment scared off by arguments with Europe and consumer demand deterred by inflation. If even Carney can revise his assessment on the referendum fallout, not to mention equities and the currency trading, it's about time the fixed income market shook off its natural despondency. Foreign investors seem already to have caught on, with BOE data Wednesday showing the highest net sales of gilts in three years. 

This all points to a need for a risk premium for U.K. government bonds. But there really isn't any. Analysts at Goldman Sachs Group Inc. say gilts are among the most expensive of the Group of Seven nations. It is not hard to see why.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.
  1. As the Bank of England is committed to reinvest coupons and redemptions there will be a slug of about 10 billion pounds of gilts bought back in September, but that is small beer compared to the hundreds of billions that have been bought.

To contact the author of this story:
Marcus Ashworth in London at

To contact the editor responsible for this story:
Jennifer Ryan at

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