UK government bonds have sold off sharply following the post-referendum panic. Recent reversals have seen 10 year bonds double in yield in just 8 weeks to 1%. This was a wake-up call for bond investors that gilt yields can in fact go up as well as down. Although this has been a savage sell off, the yield on UK government bonds, particularly on longer dated maturities, could head much higher.
The government has hinted at fiscal stimulus to supplement monetary policy and perhaps suggested that further increases in quantitative easing are detrimental to certain parts of the economy. In addition, the sharp fall in the pound, combined with a doubling in the price of crude oil suggests much higher inflation is now on the cards. This is a lethal combination that could see increased long dated issuance in the face of rising inflation whilst central banks are reluctant to raise rates or buy bonds. This is a bleak outlook for owners of low yielding conventional UK government bonds. There are only two options in our opinion, think short, or think global.
UK government bond investors worried by rising inflation could look internationally for opportunities. Switching UK assets overseas into assets such as US Treasuries, Australian and Canadian bonds could offer attractive returns on a currency hedged basis, thanks to a significantly higher yield. For investors looking closer to home, we continue to believe that the best option is to try and shorten duration where possible, and seek protection in shorter dated index linked assets.
For professional clients only. Past performance is not a guide to future performance. The value of investments and the income from them is not guaranteed and may go down as well as up and investors may not get back the amount originally invested. The views expressed are the author's own and do not constitute investment advice. Financial promotion issued by Royal London Asset Management October 2016. Information correct at that date unless otherwise stated. Royal London Asset Management Limited, registered in England and Wales number 2244297; Royal London Unit Trust Managers Limited, registered in England and Wales number 2372439. RLUM Limited, registered in England and Wales number 2369965. All of these companies are authorised and regulated by the Financial Conduct Authority. All of these companies are subsidiaries of The Royal London Mutual Insurance Society Limited, registered in England and Wales number 99064. Registered Office:55 Gracechurch Street, London, EC3V 0RL. The marketing brand also includes Royal London Asset Management Bond Funds Plc, an umbrella company with segregated liability between sub-funds, authorised and regulated by the Central Bank of Ireland, registered in Ireland number 364259, and subject to limited regulation by the Financial Conduct Authority. Details about the extent of our regulation by the Financial Conduct Authority are available from us on request. Registered office: 70 Sir John Rogerson's Quay, Dublin 2, Ireland. Ref: TH RLAM W 0011.
