December 30, 2011
(Bloomberg) — The U.K. is home to this year’s best performing government bond market as investors seek a haven in nations with top credit ratings and their own monetary policy.
Gilts have returned 17 percent on average in 2011, including reinvested interest, the most among 26 government markets tracked by Bloomberg and the European Federation of Financial Analysts Societies. They beat German debt, considered the euro area’s safest securities, by more than 7 percentage points, the most since 1998. U.S. Treasuries made 9.7 percent.
Pacific Investment Management Co., which said last year that gilts were sitting on a “bed of nitroglycerine,” now predicts the securities will beat bunds and Treasuries again in 2012. The Bank of England has supported the British economy and the bond market with 249 billion pounds ($383 billion) of gilt purchases since March 2009, a step the European Central Bank has failed to replicate to alleviate stresses in the euro zone.
“Gilts are doing well because Britain is not in the euro zone,” Russell Silberston, a money manager at Investec Asset Management Ltd. in London, said in a Dec. 19 telephone interview. “The U.K. may not be in a much better shape than countries in that region, but it has its own currency and monetary policy to deal with the problem. Investors are willing to pay premiums for that.”
Investec, F&C Asset Management Plc and DWS Investment GmbH all say gilts will outperform in coming months.
Beating Bunds
Gilts beat bunds even after volatility is taken into account. Their so-called risk-adjusted return is 2.27 percent, versus 1.54 percent for bunds and 1.87 percent for Treasuries, according to data compiled by Bloomberg. New Zealand government bonds returned the most among major markets tracked by Bloomberg, with a 4.41 percent gain on a risk-adjusted basis.
Standard & Poor’s put 15 euro nations on watch for a possible downgrade on Dec. 5, including AAA rated Germany and France, saying “systemic stress in the euro zone has risen in recent weeks.” The U.K., a member of the 27-nation European Union and which also has S&P’s top ranking, wasn’t affected.
Prime Minister David Cameron rejected an EU proposal on Dec. 9 for greater fiscal integration aimed at ending the euro- region debt crisis after failing to win safeguards protecting the nation’s financial services industry. Deputy Prime Minister Nick Clegg, the leader of the government’s coalition partner, the Liberal Democrats, said the decision risked leaving the U.K. “isolated and marginalized within the European Union.”
Gilt Record
Since then, 10-year gilt yields have fallen about 20 basis points, or 0.2 percentage point, and the pound strengthened 1.6 percent versus the euro, reaching an 11-month high on Dec. 21. Gilts yielded 10 basis points more than German bunds today, compared with a 2011 average of 36 basis points and 54 basis points over the past five years.
U.K. 10-year yields dropped to a record 1.932 percent today while two-year yields fell to their all-time low 0.271 percent. The 10-year gilt yielded 1.95 percent at 9:04 a.m. in London, with the price at 115.8i5 percent of face value.
“What Cameron did hasn’t changed our view that gilts are better and safer assets than euro-region bonds,” said Richard Batty, a global strategist in Edinburgh at Standard Life Investments Ltd., which has about $242 billion under management. “The euro zone has yet to deliver on comprehensive measures to shore up the sovereign issues. The U.K., in contrast, has one of the strongest fiscal plans which it is delivering on, and it has a better rating outlook.”
Austerity Measures
Demand for gilts is rising as the U.K.’s economic outlook dims. The Office for Budget Responsibility, Britain’s fiscal watchdog, lowered its forecasts last month for economic growth to reflect the turmoil in Europe, the biggest market for U.K. goods sold abroad.
The Office cut its prediction for this year’s gross- domestic-product growth to 0.9 percent, from the 1.7 percent it forecast in March, and to 0.7 percent for next year, from a previously estimate of 2.5 percent.
Chancellor of the Exchequer George Osborne responded on Nov. 29 by saying he would add 23 billion pounds of spending cuts to the 80 billion pounds he earlier announced, adding two extra years of austerity to eliminate the structural deficit by 2017. He also pledged to limit state pay increases to 1 percent after a two-year freeze ends in 2013.
Moody’s View
Moody’s Investors Service said on Dec. 20 the U.K.’s top credit rating depends on the government sticking to its fiscal plan and the economy isn’t immune to the turmoil in the euro area, where Greece, Portugal and Ireland have sought bailouts and leaders are struggling to keep the contagion from reaching Italy and Spain.
“Although non-euro area sovereigns within the EU — like the U.K. — can be expected to be somewhat cushioned from both the euro-area sovereign debt crisis and its rating consequences, no EU sovereign rating can be considered immune to this crisis,” Moody’s said in a statement.
Britain’s economy will grow 0.6 percent in the first quarter, while Germany’s will expand 0.9 percent, according to median forecasts in surveys of economists compiled by Bloomberg. The broader euro-region economy will contract 0.1 percent, a separate survey shows.
Foreign investors increased their holdings of gilts by 12.5 billion pounds in October, the most in 18 months, after purchasing a net 9.2 billion pounds in the previous month, Bank of England data show.
‘More Precious’
Money managers in Japan bought 1.53 trillion yen ($19.7 billion) of U.K. bonds in 2011 through September, set for the biggest annual purchases since 2008, data from Japan’s Ministry of Finance showed last month. Japanese investors unloaded the most debt in Germany, totaling almost 1.46 trillion yen, followed by sales in Italy and France, the figures show.
“Triple-A bonds will become much more precious, people will be chasing them,” Hideo Shimomura, who helps oversee the equivalent of $77 billion in Tokyo as chief fund investor at Mitsubishi UFJ Asset Management Co., said in a Dec. 29 telephone interview. Shimomura correctly predicted 10-year gilt yields would fall to 2 percent by year-end. “The U.K. could maintain its triple-A rating. It’s one of my favorites. Yields will go down,” he said.
Ten-year gilt yields may drop to 1.5 percent by June 30, Shimomura said.
Britain’s deteriorating growth outlook prompted the government to raise its planned gilt issuance for the 12 months through March by 6.8 percent to 178.9 billion pounds. Citigroup Inc., one of the U.K. debt agency’s 21 primary dealers, predicts sales for the next fiscal year will increase to 188 billion pounds. Germany said on Dec. 21 it will cut debt sales for 2012 to 250 billion euros, from 283 billion euros this year.
Rating Risk
The market will have no problem absorbing the additional gilt supply as long as Britain keeps its top rating, said Helen Roberts, who oversees about 27 billion pounds as head of government bonds at F&C Asset Management in London. Roberts said she is more concerned about political discord in the coalition than the increase in bond sales.
“If the coalition government falls, then the whole fiscal consolidation could fall with it,” Roberts said Dec. 15 in a telephone interview. “The U.K. rating is based on an expectation that the austerity measures will continue, and if that’s not the case, its top credit rating will be at risk.”
DWS, Germany’s biggest mutual fund with about $331 billion of assets, has a “positive view” on gilts even as the fund expects the economy to slip into recession in the first quarter.
A slump in the economy will prompt the Bank of England to expand gilt purchases with newly created money by another 200 billion pounds, said Andreas Burhoi, a senior money manager at DWS in Frankfurt. The ECB has refrained from so-called quantitative easing, relying instead on the provision of emergency loans to banks to soothe the debt crisis.
“We expect the BOE will stimulate the economy and the gilt market by easing financial conditions after this round of QE ends in February,” Burhoi said in an interview on Dec. 21. “This should support the gilt market,” especially maturities of 10 years or longer, he said.
–With assistance from Wes Goodman in Singapore, Shin Pei in New York and Lucy Meakin in London. Editors: Matthew Brown, Daniel Tilles