Bond heavyweights short gilts amid warnings of ‘explosion’ in yields

Bond heavyweights have begun shorting UK gilts ahead of an expected correction, warning yields have reached ‘extreme’ lows.

Earlier this month borrowing costs in Britain tumbled to the lowest level for more than 300 years, with the yield on 10-year gilts hitting a record low of 1.919%.

The yield has since moved up marginally to hover around the 2% mark, but it remains down 150 basis points from the end of 2010.

An increasing number of bond managers expect the rush by investors to the safe haven asset class to reverse  if the economic outlook continues to improve, and have started to short a variety of gilts.

M&G’s bond fund star Richard Woolnough and Thames River bond duo Peter Geikie-Cobb and Paul Thursby have placed shorts on gilts in the past few weeks.

Woolnough, manager of the £5.7bn M&G Optimal Income and £4.2bn Strategic Corporate Bond funds, began selling 10-year gilt futures last month, warning the 2% yield on the bonds does not offer ‘compelling’ value. 

Geikie-Cobb, co-manager of the £930m Sterling Global Bond fund, has built up a one-year short in 10-year gilts, taking the fund’s overall position to three years short.

Geikie-Cobb said he is shorting gilts because the asset class has reached “extreme” levels in both nominal and real yield terms, and is very well-owned by global investors.

“The catalyst for pulling the trigger on selling gilts is the improvement in the US economy, which could cause upward pressure on US treasury yields,” said Geikie-Cobb. “Bunds and gilts, however, will be the underperformers as global investors are very overweight in the context of the size of these markets.”

Geikie-Cobb added gilt yields could ‘explode’ upwards as further stimulus measures, such as the ECB’s second long-term refinancing operation due next month, cause the market to reassess growth expectations.  

“As the market’s assessment of growth improves, real yields will explode to the upside as they are at extremely low levels in Germany and the UK, especially if the political priority begins to shift away from fiscal austerity,” he said.

However other managers – while wary of gilt valuations at these levels – said shorting them is too risky because the Bank of England will keep prices elevated through quantitative easing.