Following the announcement by Bank of England at the beginning of this month that it was cutting interest rates and expanding its quantitive easing (QE) programme gilt yields have fallen to record lows.
According to Bloomberg, the yield on its UK government bonds 10-year Note Generic Bid Yield index fell to a record low of 0.501% in August.
Adrian Hull, senior investment specialist in Kames’ fixed income team, said the fall has pushed up duration risk “sharply”.
“UK gilt futures are now at record highs, as is the long end of the UK gilt market, and the total return for some gilts year-to-date has been over 50%,” he said. “But these heroic gains mean investors are now paying 50% more to get twice as much risk in terms of duration, which has moved out to 28 years for 50-year gilts.”
Hull noted that valuations across government bond markets are very rich, and further falls in gilt yields would be an issue for pension funds. While Kames central investment case was for 10-year gilt yields to remain in positive territory, Hull said the possibility remains that they will follow other benchmark government bond indices into a negative rate area.
“While events such as the recent rise for headline inflation may prevent 10-year gilt yields falling to zero, a shock – such as a terrible growth number – could force them lower,” he said. “Therefore, you can never say never.”