The headlines don’t tell the whole story: UK gilts are undermining the prevailing doom-and-gloom view. Here, Liam O’Donnell, Head of Macro & Rates at Artemis and co-manager of the Artemis Strategic Bond Fund, argues that UK government bonds could be on track to outperform internationally.
Quotation marks can make even dire warnings sound dramatic
Quotation marks are a headline writer’s best friend. They grab attention while protecting integrity. Case in point: “Britain ‘heading towards IMF bailout’”, as boomed by the Daily Telegraph late last month.
Do you see what they did there? With practically everything safely couched in a click-baiter’s punctuational weapon of choice, we’re left to infer Britain’s isn’t about to go cap in hand to the International Monetary Fund – but most likely only after we’ve first read the piece to make sure.
Fair enough. As they say in media circles: “If it bleeds, it leads.” As a bond manager, though, I can’t help thinking the UK market has been on the receiving end of some uncommonly bad and undeserved press lately.
Gilt yields have been quietly rallying despite the headlines
You don’t even need to dig especially deep to confirm the prospect of fiscal and financial oblivion may have been seriously exaggerated. Overall, gilt yields have actually rallied in the fortnight or so since the aforementioned Telegraph teaser.
Granted, there are still problems in the gilt arena. Supply is huge, inflation is too high, and the government risks tying itself in knots with its own fiscal rules. Yet I feel the current narrative of doom and gloom is unjustified in the overall global bond complex – so much so that tactically, I’m now leaning towards preferring gilts over many of their peers.
The broader global bond landscape helps put UK gilts in context
To understand why, let’s take a closer look at the broader landscape. Two events in particular have reverberated through global bond markets so far this year: February’s announcement of a groundbreaking fiscal stimulus package for Germany and April’s unveiling of President Trump’s “Liberation Day” trade tariffs.
Gilts undoubtedly felt the effects of these major shocks, as well as the turbulence from assorted lesser occurrences. Yet in the final reckoning, compared with other sovereign bonds, they really can’t be seen as an outlier in terms of movement over the past six or seven months.
Conditions now are far less dire than the turmoil of 2022
The situation definitely doesn’t deserve to be likened to the dark days of 2022, when the blessedly short-lived government of Liz Truss put the market firmly in the sights of global bond vigilantes. Although still challenging, the outlook now is nothing like as bleak as it was back then. In this episode the government are sensitive to the overall fiscal path.
The debt management office is adjusting its issuance profile to suit changing demand, helping to alleviate gilt supply indigestion; inflation isn’t skyrocketing; and the Bank of England is no longer behind the curve. Even more crucially, the same leveraged gilt exposure from the LDI and pension community, which truly was the depth charge for gilt markets back in 2022, and that which forced extreme intervention from the Bank of England, no longer presents the same risks.
Several factors suggest gilts could outperform in the near term
It might even be argued that conditions conducive to gilts outperforming are gradually falling into place. In my view, several factors may be playing into the UK market’s hands.
Poor sentiment and steep yield curves could work in gilts’ favour
First, sentiment is generally poor. To reiterate: it’s by no means as unspeakably dire as numerous reports would have us all believe – but it’s not great. This is understandable, given the difficulties of the past few years.
Second, steeper yield curves are widely expected. This gives rise to the possibility that any reversals will be both sharp and aggressive.
Third, bonds as a whole tend to rally aggressively amid fears that growth faces a significant downward shock. It’s true that longer-dated bonds can trade more like a risk asset nowadays, but they usually perform well when there’s a substantial equity correction.
Global valuation and political stability set UK bonds apart
Fourth, gilts are notably cheap on a global basis. Valuation alone is never sufficient reason to invest in bonds, of course, but it can be an added attraction if other considerations are in their favour.
Finally, our Prime Minister and Chancellor are the only political leaders openly discussing painful fiscal measures and taxes. They have a majority strong enough to deliver them, too. Meanwhile, other countries either lack the political ability to pass a budget (France) or are turning to even larger fiscal stimulus to offset headwinds from the changing geopolitical/tariff environment. This also potentially sets gilts apart from other bonds.
Ten-year gilts and longer look particularly appealing
Given all the above, I find it hard to see how gilts could underperform from here. Something truly ridiculous in the November Budget could muddy the waters, but I don’t see that happening either.
For me, right now, 10-year gilts and longer look like a sweet spot vs. global peers. I’m not making a bullish case for 10Y gilts on an outright basis, as the longer end of bond curves still faces significant headwinds, but these are more global in nature. Reading the prevailing news narrative I certainly think peak pessimism is near or already here – and that should translate into opportunity.
Beware headline tricks and remember Betteridge’s Law
As for those panic-inducing tales in the press, beware another trick beloved by headline writers – the question mark. A classic example of recent vintage: “Is Britain heading for 1976-style IMF bailout?”, courtesy of The Times.
The most prudent response in these instances is to apply Betteridge’s Law. Named in honour of a world-weary technology writer, it states that any headline that ends in a question mark can be answered by the word “no”. Beyond that, just look past the click-bait and soak up the realities of the bigger picture.
Author
Liam O’Donnell is Head of Macro & Rates at Artemis and co-manager of the Artemis Strategic Bond Fund.
