Fixed income fund managers are seeing value in the belly of the curve in the UK gilt market at aroun...
Fixed income fund managers are seeing value in the belly of the curve in the UK gilt market at around the 10 year mark, while it is the long end of the European market that is appearing attractive.
Interest rate rises are likely on the Continent as the European Central Bank (ECB) moves to quell inflationary fears. A reduction in long-dated issuance is being driven by growing GDPs and the proceeds from upcoming third generation mobile phone license auctions.
At the same time in the UK there is growing pressure to relieve the inversion on the yield curve with buy backs of short-dated gilts, issuance of long-dates, and the expectation of a recommendation from the MFR review that pension funds move assets into high grade corporate bonds.
In the UK, at close of business on Monday, 15 May, UK three-month bonds were yielding 6.15% basis points, two-years were yielding 6.32%, 10-year some 5.33%, and the 30-year some 4.49%. In the German bond market three month bonds yielded 4.25%, two year bonds 4.85%, 10 year 5.35%, and 30 year 5.55%.
Eddie Middleton, fixed interest investment manager at Britannic Asset Management, says there are continuing disinversionary pressures working at both ends of the UK gilt yield curve.
He says: "You have got the situation in the UK in which the yield curve is quite inverted. Long dates are yielding quite a bit less than the short dates.
"Going forward certainly one or two factors are putting pressure on the long end. The latest information on the pension fund minimum funding requirement (MFR) review is there is going to be encouragement for institutional investors to substitute gilts with AA/AAA type corporate bonds to offset liabilities."
On the Continent Middleton expects to see a continuance of the flattening process of the upwardly curving yield curve of the German bond market against which all other continental government bonds are priced. It is a process repeated across Europe, driven by an expected tightening in ECB monetary policy and lowering borrowing requirements created by gains from GDP growth and expected windfalls from upcoming auctions of third generation mobile phone licenses.
He says: "That would support the longer end of the market with lower levels of issuance producing a downward pressure on yields."
Middleton expects tightening in ECB policy to result in European base interest rates rising to around 4.25%, which will exert a pressure at the short end of the European bond market, pushing yields up and flattening the slope of the yield curve.
Fay Watson, fund manager at Credit Suisse, says: "The UK economy will probably start to cool down sooner than Europe, and I would recommend that UK investors stick with the UK bond market. Certainly that is what our indicators tell us. Within the UK the short end to medium-dated bonds will probably give quite a reasonable return without giving you too much risk.
"I would avoid the long end of the UK gilt market because of the disinversion of the gilt curve."
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