Fixed interest fund managers are keen on short-duration gilts in the belief that UK interest rates a...
Fixed interest fund managers are keen on short-duration gilts in the belief that UK interest rates are nearing their peak.
Long duration gilts are less in favour with Royal & SunAlliance Investments on the back of concern that demand for these assets may fall as a result of an expected change in regulations which would allow pension funds to use corporate bonds to meet the Minimum Funding Requirement (MFR).
Dave Hooker, investment manager, fixed interest at Royal & SunAlliance Investments, believes there will be a further rise in interest rates which he expects to peak at 6.5%. UK interest rates are currently running at 6% and were left on hold at the last Bank of England Monetary Policy Committee meeting earlier this month.
Hooker says: "We feel that the tightening of the labour market is one of the factors that will give the Bank of England a reason to raise rates further. We are looking at growth this year of around 2.9% with inflation at 2.1%. We believe that growth will slow to 2.5% next year. I can also see the BofE cutting interest rates in early 2001 with rates hitting 6% by the middle of next year.
"We quite like the short end of the gilt market, as the economy slows down the market will begin to discount rate cuts. We are also in a low supply environment at the short end. The Debt Management Office has announced it will buy back around £3.5bn of stock maturing between 2003 and 2008 and this buy-back could be worth up to £5bn."
Andrew Sutherland, investment director, fixed interest at Standard Life Investments, is keen on gilts as an asset class on the back of a favourable macro-economic backdrop. He says: "We are relatively relaxed about the UK economy as it seems to be slowing down quite nicely. There is no evidence of a pick-up in inflation and it is a pretty benign outlook for interest rates. We have been looking for a low peak in interest rates of around 6.5% and now we may not even get that. The gilt supply situation is also positive with the mobile phone licence auction a positive for Government finances, meaning there will be even less gilts in issuance."
Royal & SunAlliance Investments forecasts that two year gilt yields, currently running at around 5.9% will fall to around 5.8% over the next 12 months.
The group sees the yield on 30 year gilts rising to around 4.9% from 4.4% on the back of falling demand after the expected MFR changes.
The Government has also announced it intends to focus debt issuance on the long end of the yield curve which Hooker also sees as a negative for long gilts.
Sutherland adds that one concern for the gilt market is the probability of an election in the UK in the near future, which may mean that the Government may loosen its fiscal policy.
Sutherland is favouring long and short duration gilts in a bar-bell strategy and is keen on two and three year gilts where he sees the yield falling over the near term.
The yield on a two year gilt is around 5.9% and is around 5.8% on three year gilts. Sutherland says that the yields on two and three year gilts could fall to around 5.5% over the near term should UK interest rates be cut.
At the long end of the yield curve, UK Government debt maturing in 2021 is yielding 4.65%.
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