BlackRock Inc. and other large money managers are dipping back into the UK’s battered debt market, lured by one of the highest yields in the developed world.
BlackRock last week ditched a long-held underweight position in gilts, saying market expectations for more Bank of England interest-rate hikes were overdone, and enough to trigger a “severe recession.” Legal & General Investment Management has added to tactical exposure, while Pictet Wealth Management said it likes the securities.
“UK gilts have become increasingly attractive for foreign investors,” said Laureline Renaud-Chatelain, a fixed-income strategist at Pictet Wealth Management. “They offer the highest yields in the core sovereign bond space, even once hedging costs are taken into account.”
Ever since the fallout from Liz Truss’s plans for vast fiscal stimulus, gilts have been the worst performing fixed-income market across the Group-of-10 nations. They also missed out on a rally over the past three months, amid signs UK inflation is proving stickier than in the US and Europe.
Read more: UK Price Shock Sends Bond Yields to Levels Last Seen Under Truss
Money markets imply about 95 basis points in additional BOE hikes toward the end of the year, putting the key rate close to 5.5%, according to swaps tied to the central bank’s meetings. That compares to an expected peak rate of 3.75% for the euro area and 5.5% for the US.
“We think this might be a bit overdone,” BlackRock Investment Institute strategists led by Jean Boivin wrote in a note. “We closed our previous underweight on UK gilts as yields returned near levels reached during September’s turmoil.”
UK’s 10-year yield is at 4.2% — the second highest among advanced economies. That’s 2.8% in euros terms and 3.9% in dollars, according to Bloomberg calculations, more the 2.4% and 3.7% on offer for benchmark German and US securities.
Read more: LGIM Abandoned Bond Market Pricing in Midst of UK’s LDI Crisis
BlackRock and Legal & General Investment Management advocate investors proceed with caution nonetheless, favoring shorter bonds over longer ones as the BOE policy outlook is still cloudy.
Pictet Wealth Management said investor confidence on the UK bond market will depend on the government and policymakers staying the course in keeping the public debt trajectory on a sustainable path. Britain is suffering economic stagnation and the worst cost of living increases among Group-of-Seven nations.
“The selloff has been triggered by stronger growth and inflation news in the last few months,” said Legal & General Investment Management’s chief investment officer Sonja Laud. “Investors therefore need to be prepared for more short-term volatility.”
