Gilt yields are surging again, with the 2-yr. gilt yield pressing above 4.8% and surpassing the Truss tantrum peak (4.76%) on Tuesday as the employment report came in a bit stronger than expected. The Bank of England meets on 22 June and could raise rates again and talk up further rate hikes, or stand aside and talk up the risk for further hikes, or pause and take a ‘data dependent’ view. The 2-yr. gilt is a good proxy for the short-end of the gilt curve, and gives some insight into what the market is pricing in for the BoE. The long-term chart below shows the monthly closing yield. The lower yellow line is near 5% and it looks like a pivotal zone to break on a sustained basis. A case can be made for thinking that 5% will be difficult to break, but the risk is clear that a push to the middle yellow line near 5.8% could be seen. There are no doubt some ‘gilt haters’ out there who after being hammered from late 2021 till now, could be thinking that the top yellow line just above 8% may be the peak in this cycle.
We note the upside risk, but are looking for 5% to be sticky. This could see a period of consolidation around this level, with the red lines around 4.3% and 3.3% marking key yield support to watch. In other words, while there is little love for gilts at the moment, odds are that they could still fulfil a role in a balanced portfolio, and current levels are interesting. Debt traders will of course be balancing the high yields on offer in short-dated gilts vs. reinvestment risk. Locking in 4.8% for 2 years sounds nice, but what if the yield drops to 3.3% or lower over those 2-years and I can’t get that high yield? Should I be looking at the 10-yr. gilt near 4.4% instead? The chart below shows a proxy for the gilt market (over 1-yr. debt), the Invesco UK Gilts ETF (accumulating, other ETFs and funds are available!). The ETF is down over -30% from the pandemic peak, underlining the lack of love for gilts in the market. The risk is that longer dated gilts join the 2-yr. gilt and push to new cycle yield highs as well, and make a new low for the ETF. However, at some stage, the cyclical nature of economic activity, including inflation, should open up the prospect of yields falling (and the price of the ETF rising). For now, watching the pressure on gilts, see what the BoE does over the coming months?
Gerry Celaya
Chief Strategist
Keywords: Gilts
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