One week / one topic: Keep calm and refinance

What happened?

This week’s Bank of England’s 8–1 decision to hold rates at 3.75% masks a rising hawkish tail risk.

Chief Economist Huw Pill keeps warning that disinflation could stall even before higher energy prices linked to the Iran conflict feed through.

Policy impulse went from an easing bias in February to something just inching into hawkish territory as of now.

And if you – like me – are wondering “Why is there no reality TV show about disagreements between central bank policymakers?”, perhaps here is the one answer.

While recent accusations that ‘the Bank of England is the prisoner of a dying economic cult’ might be a bit harsh, there is indeed a strong degree of groupthink in policymaking circles.

After all, central bank decisions are made in the real world, where there are unintended consequences, feedback loops, time lags and shifting preferences. Not an easy job…

In the meantime – however – markets have been losing patience with Gilts and pushed yields to multi-decade highs.

To boot, the fate of the current Labour government is looking worse and worse – especially after this week’s elections delivered a major blow to Keir Starmer’s chances of staying in power, or even of getting anything meaningful done.

To stem the bleed of voters, the government might launch into further fiscal largesse - which market widely perceive as unaffordable for the UK at the moment. (Remember the ‘Liz Truss moment’?)

However, is there an opportunity in UK government bonds at the moment?

Are markets overreacting to the (undeniable) uncertainty gripping the UK fiscal and political picture, or should we just stay away and focus on other things?

Our observations

• Fundamentals: Whenever I hear anyone confidently opining on the fair value of long-dated government bonds, I have to confess low tolerance for high levels of conviction.

  Debt levels, fiscal impulse, policy preferences, competing assets, issuance all play a role here. (Plus many more other considerations) Are you sure you want to bang your fist on the table?

• Price action: With all its limitations, we can perhaps gain some perspective from observing the spread between 30yr Gilts and equivalent US Treasuries.

  While the US has been trying very hard to undermine the case for purchasing its debt, the UK spread has managed to remain at historically high levels.

• Investor beliefs: Understandably, many global investors can afford to ignore what’s going on in the UK.

  This very fact however can in and of itself present an opportunity to acquire these assets at a steep discount. But where do you draw the line?

So what?

While recent yield moves have been volatile and (characteristically) irritating, levels are largely unchanged over the last 6 weeks or so.

UK Gilts have behaved more idiosyncratically than other bond markets, in line with observable local political, fiscal and monetary concerns. All is not well…

That said, we retain positions in long-dated nominal and inflation-linked UK bonds – while watching this very closely – in the context of a broader positive disposition towards developed market government bonds.

Rest assured though, we might lose patience too at some point…

Mood music: Simply Red – Money’s Too Tight (To Mention)

By popular demand, here is the One week / One topic playlist

The information provided should not be considered a recommendation to purchase or sell any particular security.