The slump in U.K. government bonds that pushed 10-year yields to the highest in 20 months still has further to run before the securities become enticing, according to one of Scotland’s largest fund companies.
The higher yields “just confirmed our caution,” Alan Bridges, who manages 9 billion pounds ($13.9 billion) of gilts at Scottish Widows Investment Partnership in Edinburgh, said on June 20. “Yields are going to have to rise from here.”
U.K. government bonds have more than doubled their year-to-date decline since Federal Reserve Chairman Ben S. Bernanke said on June 19 that U.S. central bank officials may reduce asset purchases this year, sparking a bond selloff across the world. Gilts fell as signs of an economic recovery prompted investors to pare expectations of further monetary easing and on concern the country will struggle to attract buyers for its debt with inflation running at more than the 2 percent target.
The extra yield, or spread, investors get for holding 10-year Treasuries compared with gilts narrowed 16 basis points since June 19 to six basis points as of 5 p.m. London time yesterday. At 2.53 percent, the U.K. securities yielded the most since October 2011 and 72 basis points, or 0.72 percentage point, more than German bunds, the most since November 2010. The spread widened 15 basis points since June 19.
Gilts “will underperform Treasuries, and also bunds because of stubborn U.K. inflation and the not very favorable supply outlook for the next month,” Bridges said.
Scottish Widows Investment is the biggest Edinburgh-based money manager after Standard Life Investments. The company had 147 billion pounds of assets as of March 31, according to its website. Lloyds Banking Group Plc (LLOY), the parent of Scottish Widows, is currently mulling the sale of the fund company, people familiar with the situation said in April.
Bridges said he bought Australian bonds because the country’s economic slowdown will leave it with a central bank that’s cutting interest rates, while its counterparts keep them unchanged. The Reserve Bank of Australia, the country’s central bank, has already cut rates this year.
“A strategic position is being underweight gilts against Australian bonds,” Bridges said. “We see the Australian economy slowing down quite sharply and the RBA being able to reduce rates over the next few months while other G-7 central banks are going to be on hold.”
Australian government bonds have outperformed gilts since June 19, handing investors a 1.4 percent loss, while Italian debt declined 1.5 percent, according to indexes developed by Bank of America Merrill Lynch. After losing 1.6 percent between Dec. 31 and June 19, gilts have since dropped 1.8 percent.
Scottish Widows Investment started buying Italian bonds in the middle of May, Bridges said.
U.S. Treasuries have slipped 0.9 percent since June 19, the same as German bunds. Bonds around the world tumbled after Bernanke said the Fed may taper its $85 billion in monthly bond buying and halt its program in mid-2014 should the world’s largest economy perform in line with its projections.
The U.K. Debt Management Office may sell a bond maturing in 2068 via banks as soon as today. A sale of five-year debt last week attracted the weakest demand since June 2012. The DMO will sell two batches of inflation-linked gilts via banks as well as hold 11 auctions in the third quarter, it said on May 31.
The supply and “the global background of the Fed providing less liquidity means investors are going to be more greedy on the levels at which they buy bonds,” Bridges said.
The yield on the U.K.’s 4 percent security maturing January 2060 increased four basis points yesterday to 3.60 percent, up from 3.21 percent at the end of 2012. The 10-year yield rate has jumped from a record low 1.41 percent last July.
The Bank of England may raise its main interest rate next year from 0.5 percent to tame inflation, money markets are signaling, undermining bets that the arrival of Mark Carney as Bank of England governor next week will herald the start of looser monetary policy. Consumer prices rose at an annual rate of 2.7 percent last month.
Outgoing central bank chief Mervyn King lost his final Monetary Policy Committee vote this month as officials decided 6-3 in favor of keeping the target of their bond-purchase program at 375 billion pounds.
Like King, Carney will be “only one person among nine and he needs to take at least a majority of the MPC with him, which is what King failed to do,” Bridges said. “So we don’t expect a radical change when he takes over.”
To contact the reporter on this story: Lukanyo Mnyanda in Edinburgh at email@example.com
To contact the editor responsible for this story: Paul Dobson at firstname.lastname@example.org