Appetite for UK bonds has staged a tentative recovery in the weeks since Kwasi Kwarteng’s mini-budget sent investors dumping gilts at the fastest pace in decades.
Investors are betting that the risk of British companies defaulting on their debt is already priced in high bond yields and they have lowered their expectations of future interest rate hikes.
The price of 10-year government bonds, seen as a proxy for the cost of government borrowing and confidence in the UK economy, collapsed, pushing yields to the highest in more than a decade in September after that Kwarteng, who was then the chancellor, scared off investors by revealing £45bn of unfunded tax cuts. Yields move inversely to bond prices.
However, flows into UK bond funds turned positive in October as retail investors were attracted by higher sterling bond yields and the prospect of more stable fiscal policy. Net inflows into UK bond funds totaled £308m last month, according to Morningstar data, recouping some of the losses suffered in September when investors withdrew £640m from UK bond funds.
Returns paid on sterling corporate-issued debt have been driven by higher yielding UK gilts, as well as wider spreads (the gap between the return you get from holding a potentially riskier corporate bond instead of a government bond) to reflect a darker trend. economic prospects. Government bond yields have fallen in recent weeks after the arrival of the new prime minister and chancellor raised expectations that government policy would be more in line with the Bank of England’s efforts to control inflation.
“Even LDI [liability-driven investment] Funds that have been forced to sell UK fixed income are now looking to put money back into fixed income,” said Ben Edwards, the lead manager of the corporate bond fund at Blackrock, the world’s largest asset manager.
The September drop in UK debt led to a collapse in pension funds, which are large holders of UK gilts, as they faced large demands for additional cash from liability-based mutual funds to cover the losses they were suffering.
“People are taking notice, they can see the returns that are being offered,” said Kris Atkinson, a fund manager at Fidelity International, which has been overweight UK debt within its global corporate bond funds on the assumption that the recession has already been valued in investment. debt grade.
The recession has led investors to lower expectations for interest rate hikes, and markets are now trading at a peak of just over 4.6 percent next August, compared with a rate expected last month of 5.25 percent.
Atkinson said: “We believe we are past the worst of rate volatility. That’s not to say it’s over yet, the market is still pricing in more increases, but it is a slowing down of the pace of those increases.”
However, companies are still hesitant to try to raise funds in sterling. Issuance amounted to $9.3 billion in November, according to Refinitiv data, below historical norms. That was largely attributed to banks, including Morgan Stanley and Barclays, which inherently take on debt more regularly to finance their loans.
The strongly signaled sale of corporate bonds by the Bank of England, which was delayed after the market collapse in September, has also weighed on issuance, said Michael Matthews, who helps lead Invesco’s fixed income team. “There’s so much supply coming from that that issuers were going to have to pay a premium to get into the UK market,” he said.
Corporate debt issuance has been outpaced by companies repaying their bonds, with Tesco and GSK buying back debt this month. “If you think we’re getting close to the peak of rates… then for the companies that are bidding, this is probably the lowest cash price they’re going to get on these bonds,” Atkinson said.