Partner Insight: The weaker turn in the global environment along with lower oil prices proved to be supportive for safe fixed income investments last year, but with Brexit looming and causing more economic uncertainty, what is the outlook for the asset class?
Gilts had their best month in more than a year to end 2018. It was notable, however, that long-term investors were reluctant to chase these returns; flows into the Gilt market across the quarter remained close to their five-year average. The only bright spot from the point of view of investor behaviour was an improvement in demand for 30-year Gilts in December, although even this did not offset selling seen in the first two months of Q4.
The main challenge is what happens to short-term interest rates. The Bank of England has made it clear that the uncertainty surrounding Brexit is a key restraining factor in its rate cycle. This may change over first quarter if weak December data prove to be a sign of a much weaker economic trend. For the moment, SSGM still assume that any news suggesting Brexit uncertainty will diminish is a potential negative for the front end of the Gilt market.
For now, the good news for Gilts is that the uncertainty surrounding Brexit is proving remarkably stubborn. Deadline after crucial deadline has passed without providing any clarity on the likely path. In theory, one might expect that the best case scenario for Gilts would be the worst case economic scenario, a no deal Brexit with the UK crashing out of the European Union on 29th March 2019. In contrast to the original referendum result, which posed a threat to confidence rather than an immediate impact to the real economy, it is assumed that a no deal Brexit and abrupt shift to WTO terms for trade would have an instant impact on the real economy. In the scenarios published by the Bank of England, growth could contract by as much as 5% in 2019 as a result of this shock. As the Bank did in 2016, such a shock would likely to be accompanied by the resumption of quantitative easing and Gilt purchases.
Click here to read the full article and an analysis of what challenges the Gilt markets could see if a sharp depreciation in sterling or a ramp up in inflation occurs in the coming weeks.