The FT has noted this morning that:
Holders of UK government bonds are suffering the worst quarter in at least two decades as Britain's economic prospects brighten, setting a contrast with the eurozone where a more sputtering recovery from the coronavirus crisis is helping haven assets hold their value.
This needs a bit of unpacking.
What the FT is saying is that in the UK bond prices are falling because there is now an expectation that, at the very least, interest rates have reached their low point and may even begin to increase when previously it was thought that they might become negative. In contrast, there is much less optimism in the EU. As a result EU bond prices are not falling at the same rate.
And to explain the relationship between bond prices and rates, most bonds are issued with a fixed interest rate over their whole life. As a consequence bond prices go up if interest rates fall, and vice versa. This then, broadly speaking, creates a current interest rate on the current price of the bond when the actual interest payment does not alter.
The FT message is, in that case, that markets are significantly more optimistic that the UK is over Covid than they are that the EU is. I would, of course, describe that as misplaced optimism. I am not alone. As the FT also notes in the same article, this is sentiment and not fact, and sentiment might be misplaced, or as one analyst put it:
I would say we are priced for something close to a best-case scenario over the coming months.
I think that right.
What was that old saying about pride coming before a fall? Or rather, in this case, pride coming before a bond price increase?
The economic shocks of this are not over yet.
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I am not sure that rising bond yields are saying too much about the outlook for COVID in the UK. Yes, there is some sense that we are coming out from the worst of the pandemic and there is certainly room for disappointment but gilt yields are STILL at very low levels. I think we need to look at the US to see what is going on.
Over the last year EUR 30 year rates are up 3bp (1bp = 0.01%), JPY 30y rates are up, 22bp, UK + 39bp and US + 87bp. Why?
It’s about the fiscal response that governments are making in the face of QE. The Fiscal stimulus package of USD 1.9 trillion is massive (a similar sized package in the UK for our size of population would be £300bn!… the same again on what we have already spent). The US will keep spending whatever it takes to support the economy. In contrast, the EUR zone comprises countries without monetary sovereignty who can’t deliver the spending required without broad agreement…. and this is hampered by “balanced budget” fetishists in Germany. The UK (a backwater in global financial terns) lies somewhere in between.
Personally, I think the US has got policy about right – massive support to business and individuals plus infrastructure projects….. with the Fed allowing a modest rise in yields that might constrain asset prices (but always ready to intervene if the rise in yields becomes precipitous.
In the UK it appears that any further support for people and the economy will only be as a result of things getting worse,,,, and that “tight-fistedness” increases the probability that things will get worse.
You might be right that that bond yields are priced for a best case scenario for the short term future, but equally you might also be wrong. Lots of data is pointing to a far faster economic expansion when this pandemic is finally over as well.
With that in mind, the 10y Gilt trading at 0.75% today, who would want to own them?
Real yields are negative. Supply is going to be massive, and there is no real demand as the big owners of bonds are already full. Budget deficits are still large. QE can’t and won’t go on forever. The money supply has increased massively. PMIs are well over 50 and inflation base effects are going to naturally push inflation higher.
If things don’t work out there is limited space for Gilts to rally – but the opportunity cost of not being long or actively being short is very low, thanks in part to negative real yields. There is a lot of room for yields to move higher – as we have seen over the last couple of months.
To actually make a real return on a long Gilts position at these yields, you have to be hoping for another major crisis or dramatic worsening of the current one. A small rally/move lower in yields won’t offset the real terms losses.
So the markets may be wrong, but at the moment why buy Gilts? The risk/reward of doing so if terrible.
There is no sign of far faster economic expansion. Please live in the real world
There is no sign of significant bond issuance being likely either. Heard of QE?
And where are the inflation base effects when there is no wage pressure
And people are owning gilts
How much can you get wrong in a single comment?
No signs?
How about manufacturing and services PMIs. Quarterly earnings. Etc. All the fast response data is looking very strong. Have you got any real world data (not just your opinions) that point to things getting much worse?
Not sure what world you are living in, but there is huge bond issuance at the moment, and there will be going forward. QE buys it up, but QE can’t and won’t go on forever, as I’ve said.
You clearly don’t understand what inflation base effects are. Has nothing to do with wage pressure. Everything to do with how inflation is calculated.
People own Gilts, but they aren’t buying any more of them. They’ve actually been net sellers this year. The only net buyer of Gilts has been the BoE, and that as i ahve said is not going to go on forever.
“How much can you get wrong in a single comment?”
Considering you’ve got everything wrong in your reply to me?
Anyway. I ask you this question. Why own Gilts at 0.75% yield? How can you achieve a decent positive real return from it?
At best you might break even. Assuming yields don’t move and inflation stays low. To get a real positive return you would Gilts to return to their all time lows in yields – then sell them anyway.
At worst, you could stand to lose a lot should yields and/or inflation move higher.
Invest in a decent trend follower or DRP fund instead and you’ll get much better returns with much lower risk than just investing in Gilts.
So why, as I say, would anyone in their right minds be buying Gilts at these yields at the moment (here’s a clue – the data shows they aren’t)?
Let me deal with just one issue, that of bond issuance
Issuance was net of QE less than £50bn last year, which is pretty low for post 2008 years
So you got something very basic wrong
I think we can safely dismiss the rest
So to be clear you would advocate buying long dated gilts even tough they are guaranteed to lose money in real terms? And with the risk/ reward is asymmetrical..I.e limited upside and and a lot of downside. It sounds like an incredible aggressive bet to take on board such duration risk from these levels.
I am saying people are doing so
I am not offering investment advice
You said:
Issuance was net of QE less than £50bn last year
I said:
…there is huge bond issuance at the moment, and there will be going forward. QE buys it up, but QE can’t and won’t go on forever…
So which part did I get wrong? NET bond issuance is only low BECAUSE the BoE is buying it all.
But that can’t and won’t continue forever. Got that?
It’s almost as if you’ve not bothered to read what I said and created a straw man argument all of your own. Insulting me whilst you are at it.
Now that argument of your has been thoroughly destroyed, could you tell us why Gilts are such an excellent investment? I hope you have all your money in them if you think it is the case.
They can and they will keep buying
And the wight of evidence if all on my side
I’m guessing you mean the BoE?
No, they can’t. They’ve said as much already.
Either way, if the BoE keep yields low through QE, which will mean they keep having to continually expand the money supply, the risks to inflation keep growing on the upside. It also keeps shortening the maturity of debt which creates even more risks to the treasury funding cost.
Which makes those Gilts you keep telling us are great investments look even worse.
You don’t seem to able to come up with a good reason for anyone to buy Gilts. The market and it’s participants aren’t stupid, and have weighed up the risk/reward of Gilts and found not owning them to be the best plan.
You seem to be one of the very few people out there saying they are good. That either makes you some kind of prophet, some kind of perpetual doom-monger or some kind of stupid. Which is it?
The Bak has said a lot of things we need not believe, including the fact that it ios not deficit funding the government and that it is independent so why should;d iI be;live anything it says on QE?
And what is the risk of expanding base money? You do realise that is what is happening don’t you? And you know that as it stands that is not inflationary, again, don’t you?
Or rather, I suspect you don’t. And that’s why you are rude rather than having an argument.
Your next one had better be good, or it will not get posted.
Well, we’ll see soon enough regarding the BoE. The consensus view, led by the BoE itself is that QE won’t continue forever, which means deficits will have to be financed some other way.
And the risk of expanding the money supply is inflation. That there hasn’t been inflation so far doesn’t mean there won’t be in the future, and as we know from history, the money supply is one of the big drivers of it.
Anyway, enough of that. Let’s get back to the main point. Gilts, and why you think they are such a good investment.
You haven’t really given us a reason why people should be investing in them, given the terrible returns and very poor risk/reward. Could you do us a solid and explain why Gilts should be the investment of choice?
Only a trillion or so held in them right now
Now you tell me why
The evidence is very strong that people want them
So you tell me why they shouldn’t
And if you refer to rates alone you will fail. Just a hint there
That’s not an answer. Because other people bought them when yields were higher?
I asked you why people should be buying them now – and you can’t answer that.
Instead you are asking me a question. You are the economics expert making the claims you have in the blog. Not me.
I’ve already told you why buying Gilts at these yields is a bad idea. You tell me why it is a good idea.
Then we can go from there.
Reasons:
Security
Regulation
Repo
Currency holding
Portfolio balance
Risk aversion
Mistrust of inflation forecasts
The list goes on and on
And you aren’t even aware of it
I think your time here is up
“Security”
There are other secure assets which are almost as secure but with far better return profiles.
“Regulation”
Being forced to hold something doesn’t make it a good investment.
“Repo”
Doesn’t affect the rate of return on your investment significantly.
“Currency holding”
? Not sure what you are getting at here.
“Portfolio balance”
Again, doesn’t make it a good investment. If you are looking for fixed income, go buy some credit.
“Risk aversion”
Again, not a good reason to buy them. Why not have cash instead, which has no risk either but no chance of losing capital value.
“Mistrust of inflation forecasts”
This is the only one of your answers which you could argue makes them a good investment. But even if inflation doesn’t go anywhere the returns you are going to get are going to be awful, especially for the risk. And if inflation does go higher you are going to get destroyed by holding Gilts.
“I think your time here is up”
Think your time as an economics, investing and finance “expert”nevrer started.
Let’s conclude
You think people holding more than £1 trillion of gilts rate misguided
They don’t
I appreciate why they behave as they do
You don’t
I’m backed by £1 trillion
You’re not.
I think that’s the moment to close this
Scale of ownership in no way points to a good investment.. for example around $350 billion was invested in Mortgage backed CDOs before the crash in the US housing market in 2008. The scale of gilt ownership in no way makes the investment story compelling.. long dated gilts are guaranteed to lose investors money in real terms, it is all a question of how much..
So, £1trn of ownership is deluded?
Of course….
Well $30 trillion is invested in US equities.. with your logic that make them a sure fire bet..
Scale of ownership in no way reflects the investment opportunity!!!!
I suggest reading Reminisces of a Stock Operator. Though written in the 1920s, it is far from outdated and looks at the psychology and danger of “herd investing”
I have already explained that there are many rational reasons why organisations in the main wish to hold gilts. You seem to be entirely unaware of such things, but you would understand markets a great deal better if you did.