Royal London’s Craig Inches says fears of a dramatic and prolonged spike in gilt yields are unfounded.
The £267m UK Government Bond fund co-manager expects 10-year gilts to reach a high of 4.5% in the next few weeks and end the year at 4%. He says there is no evidence the Government’s record borrowing programme and the ending of quantitative easing will push yields to record levels.
“Lots of yield forecasts are predicated on the issue of supply. However, our research shows over last 30 years the correlation between supply and gilt yields is zero,” he says.
“Supply creates its own demand, and in that environment you never have a problem selling them because people want a risk-free asset.”
Consequently, Inches has begun increasing the fund’s duration. The fund was 0.5-years short duration compared to the benchmark at the start of this year, but when 10-year gilt yields reached 3.8% last month they moved to 0.5-years long duration.
“We are going long again. We think now is a good opportunity for buyers of government bonds,” he says.
The manager believes a UK ratings downgrade is unlikely but is not phased by the prospect if there is one.
“If you look at the 10-year gilt, it is already yielding higher than Italy, so the markets are already trading it like a double-A security. If we see a confirmation of the UK’s AAA rating following the election, it is another reason yields could come down,” he says.
Meanwhile, Inches has cut non-UK exposure from his £145m Index Linked Gilt fund, following the January inflation report, which said CPI reached 3.5%.
“Linkers came under pressure after the report and although we cannot be underweight UK linkers, the spread on our US and French bonds moved a great deal, so we decided to take some profits,” he says.
Inches says the most optimum place in the UK linker curve is between maturities 2022 and 2027.
“Short-dated linkers remain under pressure because the inflation report said CPI is going to undershoot its target.
“The longer end of the curve is under pressure because the stimulus is expected to be inflationary over time.”
