Bond Watch: has the Bank of England saved the bond market?

Sam Benstead runs through the most important news stories of the week for bond investors.

Welcome to interactive investor’s weekly ‘Bond Watch’ series, covering the latest market and economic news – as well as analysis – that is relevant to bond investors.

Our goal is to make the notoriously complicated world of bond investing simpler, by analysing the week’s most important news and distilling it into a short, useful and accessible article for DIY investors.

Here’s what you need to know this week.

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All calm after a dramatic week

Bond markets have stabilised following the intervention by the Bank of England last week. The Bank said it would step in and buy long-dated gilts until the 14 October to prop up the bond market amid a rush from pension funds to sell bonds and raise cash. It said it stepped in to protect “UK financial stability from dysfunction in the gilt market”.

This had the effect of supporting bond markets, with prices rising and the yield on the 10-year UK gilt falling from 4.5% to 4%. That’s not to say bond inventors are over the worst of the fall in prices and rise in yields.

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Prime minister Liz Truss’ speech at the Conservative party conference this week was not taken well by markets, however. While Truss set out commitment to fiscal discipline, there was no more detail on how she would be fiscally responsible. The 10-year gilt yield rose from 3.8% to 4.1% in response.

Investors see value

The rise in bond yields is attracting income-hungry buyers. There was a 400% year-on-year jump in gilt-buying activity among interactive investor customers in the week following the mini-budget, which triggered notable bond price falls, and therefore higher yields. 

Customers are buying bonds set to mature in the next couple of years, suggesting they intend to hold on to the gilts until maturity, and collect income payments along the way.

While bond prices could fall further if the Bank of England needs to raise interest rates more than markets expect, a 4% yield is nothing to sniff at. Investors would have to go back to 2008 to get a similar return by lending money to the UK government. If inflation falls to normal levels, that 4% fixed return will become even more appealing. 

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One professional who has been buying is David Coombs, head of multi-asset investing at Rathbones. He believes bond markets overreacted to the government’s spending plans and gilts were now good value.

Coombs said the bond market moves were an overreaction driven by a lack of context from the government and political naivety.

He said: “In essence, Kwasi Kwarteng and Truss didn’t sell it and they didn’t listen to constructive challenges. Consequently, we did buy gilts in our lower and mid-risk multi-asset portfolios last week as five-year yields jumped above 4.5% (5% in 30-year bonds) as we felt those levels were approaching fair value and above where we believe inflation will settle over the coming few years.”

Mortgage rates jump

The consequences of higher interest rates are being seen in the mortgage market, with banks putting up rates.

The average two-year fixed rate deal now costs 6.07%, according to data firm MoneyFacts, which is the highest level since November 2008.

This means for someone with a 25-year £200,000 loan, the cost of borrowing on a two-year deal has risen by £158 a month in just two weeks.

A year ago, the average two-year rate was 2.34%, meaning that a 25-year £200,000 monthly loan cost £881, compared with £1,297 today.

Investors are worried about the knock-on effects for the economy, as lower disposable income slows economic growth, and house prices could fall due to the cost of borrowing rising.