As the 10-year gilt yield rises and falls with unfamiliar frequency, will more investors leave the bonds market and focus on low-correlation assets such as commercial bonds and property?
- UK government bond prices have fallen back to levels last recorded before the EU referendum
- The 10-year gilt yield has also twice dived significantly over the last four months, but has now risen to its highest level since June
- Such nervousness and volatility has begun a UK bond sell off – so should more investors focus on stable long-term assets such as property instead?
Can investors still rely on UK government bonds?
Following the EU referendum and ongoing inflation fluctuation, investors are demanding higher rates of interest for lending to the UK, causing prices to fall back to levels last seen before the referendum vote on June 23rd.
But it’s the performance of yields that have given investors the most cause for concern. Twice they have dived in recent months, first immediately post-Brexit, then again in August when the Bank of England reduced the base rate of interest to 0.25%. Now, however, the 10-year gilt yield has grown to hit its highest rate in four months, further underlining its current volatility.
“There’s been a shift in dynamic since the start of October that’s very unusual for a G10 currency, particularly for sterling, where higher yields are corresponding with a weaker currency,” said BNP Paribas currency strategist Sam Lynton-Brown.
“At the moment, rather than higher yields driving sterling, you had a weaker pound driving higher inflation expectations, in turn driving a steeper and higher UK rates curve.”
While some in The City are remaining optimistic, others are warning investors to reconsider their strategies, with further price declines and bond yield rises likely to come.
“Rising energy and import prices look set to push up retail price index (RPI) inflation to about 4% in one year’s time, exceeding markets’ current 3% expectation,” said Samuel Tombs at Pantheon Economics. “We therefore still think gilts are mispriced for the looming inflation shock.”
While the economic fundamentals of investing in the UK are unchanged following Brexit, the result of the referendum has caused some immediate investor uncertainty, causing fluctuations in several markets.
But, just as those with equity-heavy portfolios may need to now look for a low-correlation, high-returning asset, should bond investors consider acquiring commercial bonds and property assets in the long-term?
Though other markets may suffer from volatility as the UK still plans its exit from the EU, the demand and supply imbalance in sectors such as the build-to-rent market means that property, for example, is likely to be more resistance to external economic developments.