Gilt yields have been drifting lower due to the projection that the UK economy is going to outperform. With an interest rate hike likely this year or next, gilts will be affected, and the general market consensus is that a rise will happen first in the UK, followed by the US.
Fixed income can always be an important part of a balanced, diversified portfolio, but it is looking increasingly unlikely that government bonds – UK or otherwise – are the answer.
The state of play
With low inflation and strong employment statistics, the UK is being lauded as a monetary success story and looks to be first out of the blocks in terms of central banks raising interest rates. The UK’s market data has been strong, but we are still in a relatively low-growth economic environment. While consensus is that economies are growing and the tapering of quantitative easing (QE) means we are heading for a boost to GDP, there is also the chance that growth will be lower than pre-crisis because of how the financial crisis affected the economy. The US, for example, had its first quarter growth figures revised to show a contraction in GDP, rather than the small expansion that had originally been forecast.
A particular problem with predicting what will happen to bond markets is that the current economic environment is different to any we have experienced in the past. QE creates new economic conditions, and no one knows for sure how the market will react. Predictions are being based on previous rate rises such as the Fed in 1994, but that is not necessarily an indication of how bond markets will react when QE ends.
Out of favour
The UK has come a long way in the six years since we saw endless queues of savers waiting to get their money out of Northern Rock, and the economy is getting back to a semblance of pre-crisis ‘normal’. Given the amount of stimulus, rates in the UK have been at all-time lows for such a long time that gilts have failed to offer an inspiring option for investors. As Table 1 shows, no UK gilt funds or index- linked gilt funds have returned a profit on an initial £1,000 investment over the past year.
“In terms of the UK gilt market, we’ve basically done no trade over recent weeks,” says Mike McCudden, head of complex products at trader and investor community Interactive Investor.
