Gilt Trip

For the fixed income markets, it’s ultimately all about the creditor being able to pay back what is owed. As such, there is a lot we can learn from current gilt yields about investors’ perception of the UK government’s ability to repay the £2.6 trillion it has borrowed. Up until March, things were fine. Short-term yields were headed lower and two-year Gilts were to be had for 3.5%.

Now, we are just over 4.5%. More worryingly, 30-year gilt yields are now at a 28-year high of 5.85%, which means the underlying bonds have lost close to 15% in a mere two months. These are not the types of moves you normally see in developed sovereign debt markets, but then again, an energy crisis clearly was not enough excitement for Britain, so we also decided to throw in the uncertainty of a political leadership contest.

Nevertheless, it is highly unlikely the UK government would ever default on its debt and technically, it never has, depending on how you define the 1932 war loan conversion. Besides, governments with their own currency can always print money, or we could turn to the IMF for a bailout, as we did in 1976. So, should we really be worried, or are gilt markets simply oversold and detached from fundamentals?

Surely, one would have to be highly sceptical that the Bank of England is going to raise rates three more times in the next 12 months. The UK economy can barely tolerate where rates are today. It also seems unlikely that pension funds have suddenly abandoned decades of long-term liability matching simply because yields moved higher. In other words, the gilt market may not be signalling default risk so much as a temporary buyers’ strike that could persist for a while longer.