Bond Watch: what the gilt sell-off means for your money

Welcome to interactive investor’s ‘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.            

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Gilt yields soar 

Investors are dumping UK government bonds, as confidence in the government’s ability to bring down inflation and grow the economy declines.  

While bond yields are rising globally, the difference between yields on similar US and UK government bonds (known as the spread) has increased, showing that the UK faces greater scrutiny from bond investors than other markets. 

Now the 10-year gilt yields 4.8%, ahead of the US 10-year bond’s 4.7%. A year ago the UK 10-year was at 3.8% and the US 10-year was at 4%.  

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Deutsche Bank analyst Jim Reid notes that the 30-year gilt yield hit its highest level since 1998 this week, at 5.35%.  

Gilts are being sold, pushing up yields, for a number of reasons: 

1) There is a general lack of confidence that the Labour government is on the right track, and it could now have to borrow more or implement austerity measures. Investors are already looking ahead to the Spring Budget and the impact it could have on the economy and capital markets. Rising debt costs are also putting more pressure on the fiscal position.  

2) Inflation has been ticking higher, hitting 2.3% in October and 2.6% in November.

3) Fears of stagflation – low or no growth, or recession, combined with rising inflation is very bad news for the economy.

Rising gilt yields mean that the UK government has to pay more to borrow. Capital Economics, a consultancy, says that higher gilt yields have already added £9 billion to government borrowing costs, which virtually wipes out the £9.9 billion spending buffer that the Treasury has built up with tax rises. 

Now, higher borrowing costs could lead to higher taxes or spending cuts, or both, in order to balance the budget. This could undermine economic growth and damage confidence further in the UK.  

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Meanwhile, investors are also dumping the pound, which has dropped nearly 2% against the US dollar so far this year. You would expect rising gilt yields to be accompanied by a rising pound, but that is now the case.  

Mike Riddell, portfolio manager, Fidelity International, says: “Normally currencies are driven by interest rate differentials, where higher gilt yields relative to other countries would be expected to push the pound stronger. The combination of a weaker pound and higher relative gilt yields has eerie echoes of August-September 2022, and if this continues, could potentially be evidence of a buyer’s strike or capital flight.” 

10-year gilt yield rises over the past 12 months to 4.8%

Past performance is not a guide to future performance.

What does this mean for investors?  

I’d highlight a number of consequences for bond investors: 

1. Holders of bonds would have seen their portfolios drop in value, particularly if they are in funds where the bonds have a high “duration”, or sensitivity to interest rate changes. Because bond funds own bonds of a range of maturities and there is no fixed maturity date for a fund, the market value of the portfolio will move as economic conditions change.  

2. Those owning gilts maturing in the next couple of years, and intending to hold them to maturity, will not have seen a big shift in the value of the gilts. The price of the bonds will tick slowly towards the £100 redemption value as the bond nears its maturity date. While markets are losing confidence in the UK government, there is no doubt that it will not meet its debt payments. 

3. However, this is not true of all gilts. One popular trade among customers is the UNITED KINGDOM 0.5 22/10/2061 (LSE:TG61) gilt, maturing in 2061 – the low 0.5% coupon and long maturity dates make it extremely sensitive to sentiment changes. The price has gone from £32.50 in September 2024 to £26.50 today, so some investors may be nursing heavy losses. Others could see this as a buying opportunity.  

4. Rising gilt yields mean that investors looking to put new money into bonds are getting better expected returns than before. This is good news for investors looking to allocate to bonds. With the popular UNITED KINGDOM 0.25 31/01/2025 (LSE:TN25) gilt maturing at the end of the month, investors looking to reinvest this in short-term bonds will likely be able to lock in a higher yield than when they purchased the gilt – in this story I highlight options for gilt investors looking for low coupons and short maturity dates.