What are gilt yields telling us?

Thank you for your responses to our UK Uncensored Brexit articles. I’ve been reading through them. And I share the frustrations that have been expressed by several readers about Britain’s so-called democratic processes.

TV images of our posturing parliamentarians consistently failing to deliver on the country’s June 2016 referendum vote will live long in the memory. It’s hard to see how a three-month divorce delay will properly resolve the UK’s departure from the EU in line with the popular vote.

As the Westminster chaos continues, then, are financial markets fretting?

Answer: not a lot! Sure, there are occasional wobbles in both the stock market and sterling. But there’s nothing really to write home about. And one of the best barometers of confidence in the country – the gilt market – seems nearly asleep.

At a historically-very-low 1.07%, the yield on 10-year UK government bonds is exactly the same level as it was before the Brexit referendum.

Now gilts aren’t some arcane financial instrument in the playbook of professional money managers. They’re Britain’s benchmark for borrowing money over lengthy periods for both companies and private individuals. And because they determine the returns we receive on our pension pots, they’re of vital importance to all of us.

So what’s the real message for you from current UK gilts yields?

Politics not economics

I’ve always maintained that Brexit is a political rather than economic event. That’s been borne out by the way the pound has traded in a narrow range over the last two years and nine months. It’s currently standing at around $1.31 and €1.16 despite all the dire predictions of potential parity against both the US dollar and the euro. The FTSE 100 index, meanwhile, has risen by some 20% during this period.

The gilt market has been driven by some of the same influences. Quantitative easing (QE), i.e. the monetisation of (largely government) debt by the Bank of England, has been a major factor in driving up prices of bonds and thus compressing the returns they pay investors. In addition, the low level of ‘long’ gilt yields reflects the improvement in UK government finances that I wrote about last week.

Incidentally, a subscriber has written to me suggesting I’m ignoring the fact that this country is continuing to live beyond its means with our national debt at some 80% of GDP. It’s a fair point about the level of UK and indeed global government debt. But compared with history, a 1.07% 10-year gilt yield is so low that it implies the Treasury should have hardly a care in the world. Brexit: no bother?

If only it were that simple. Because there’s another very specific reason why gilt yields are as depressed as they are.

They suggest that a further economic growth slowdown could be on the way for the UK. Indeed, they imply we could even see a recession. That would reduce demand for money and thus lower the price, i.e. the interest rate. And it could well be accompanied by more of the same central bank monetary meddling that we saw in the wake of the great financial crisis a decade ago.

In other words, further QE may be in store.

And we’re not talking solely about the UK. This is much bigger than Brexit and the EU put together. It includes much of the world, in particular the US.

Here, the Federal Reserve had been reversing its earlier QE with QT (otherwise known as quantitative tightening, which is cancelling the extra cash it had previously created). Yet in this week’s FOMC (Federal Open Market Committee) meeting, the Fed has cut its median forecast for 2019’s GDP growth to 2.1% from 2.3%. This now implies no rate hikes this year, while QT will cease in September.

This follows the European Central Bank announcing plans last month to boost liquidity with various types of LTROs (don’t ask!).

Indeed, sorry about the jargon overload. But the bottom line is clear.

I reckon that another globally co-ordinated QE scheme is being hatched by central banks. This could buy up much of the government debt that will be issued to fund extra state spending aimed at offsetting fears of dwindling economic expansion.

As next year’s US Presidential election campaigning hots up, there’s been much discussion amongst Democrats about Modern Monetary Theory (MMT). Don’t be fooled by the smooth-sounding title. It’s just more of the same money printing as before, but under another name.

Whatever it’s called, though, more QE would – at least for starters – further suppress yields on government bonds on a global scale.

Societe Generale’s uber-bear Albert Edwards, one of my favourite economic commentators, has this to say on the subject: “my current forecast of US 10-year bond yields of minus 1% in the next recession… is being met with the same hilarity as in 2006.  But the next recession is on its way and we should get used to negative yields”.

That chimes with Doug Kass of Seebreeze Partners. He’s noted “today’s fundamental message of the fixed income markets”. Though these are“being ignored” they “could be presaging weakening economic and profit growth relative to consensus expectations”.

Where US 10-year Treasury bond yields go, gilts normally follow. Post-Brexit, I believe that the UK’s economic outlook could prove better than widely expected. But long gilt yields could still drop further.

To repeat, that wouldn’t be helpful for your pension returns. It would be very good news, though, for an investment that absolutely thrives on negative interest rates. To find out about this, take a look at the latest research from Strategic Intelligence here. And we’d love to see your comments about this article: please email us on ukuncensored@agora.co.uk.

2 Comments
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