Markets

Marcus Ashworth is a Bloomberg Gadfly columnist covering European markets. He spent three decades in the banking industry, most recently as chief markets strategist at Haitong Securities in London.

Yields on 10-year U.K government bonds, or gilts, have slipped below 1 percent. Maybe not the strangest thing during an election campaign in which Theresa May sails on serenely toward a whopping parliamentary majority.

Yet what's been the bond market reaction since her leftwing rival started to make more of a fight of it? Pile into gilts, pushing yields down even further.

A Yield in England
Gilts have unwound all the post Trump move and have headed back below 1 percent
Source: Bloomberg

In the bizarre pre-election world of British government debt, it seems whatever outcome you expect, you get the same result. Comfortable majority for Theresa May, yields dip. Polls tightening on signs that Labour Party leader Jeremy Corbyn might be less hopeless than thought, yields dip. Nightmare scenario of a hung parliament, yields dip.

Putting aside the notorious unreliability of British polling, this isn't just bond investors being magisterially indifferent to political risk. It's more like a Twilight Zone episode, where all roads lead to the same place: Gilts Town.

A large majority for May's Conservatives should let her negotiate a Brexit deal with less pressure from the hard leave camp. So you can see why gilts might respond positively to that prospect, as a successful Brexit deal would attract new investment into the U.K.

But at the same time, gilts' status as a haven asset means they're also somewhere you can turn to when there's the possibility of an unhappy outcome such as a Corbyn success, however unlikely that is.

All this has left gilts looking significantly over-valued. Major government bond markets, such as U.S Treasuries and German Bunds, have also been yielding less of late. But gilts are the stand-out performer.

Gilts Forge Their Own Destiny
U.K. yields are not just following Germany but have significantly outperformed this year
Source: Bloomberg

 

New Territory
Gilts have not yielded this much less than U.S. Treasuries for a generation
Source: Bloomberg

U.K. CPI is running at 2.7 percent, meaning that real yields after inflation are minus 1.7 percent. Hardly compelling, especially as there are no longer central bank QE purchases to sustain nose-bleed valuations.

A slimmer-than-expected majority for May would no doubt be be negative in the long term because of the problems of keeping her Europe-baiting Brexiteers in check. But it's not as if the "May with a comfy majority" scenario is risk-free. Regardless of the complexion of the next government, sales of government debt will have to rise ever higher. Yet gilts remain impervious, locked in buy-and-hold mode. The one thing in this electoral campaign that really is strong and stable.

The election will finally be over in a week's time. Gilts will then have to be valued on the new government's spending plans, future inflation expectations and the success or not of Brexit negotiations. Sub-1 percent 10-year yields may not stand up to those headwinds for too long.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the author of this story:
Marcus Ashworth in London at mashworth4@bloomberg.net

To contact the editor responsible for this story:
James Boxell at jboxell@bloomberg.net