9th June 2016
The yield on the benchmark 10 year gilt has fallen to a record low, dropping below 1.25% for the first time and bottoming at 1.22% (so far).
This contrasts significantly with this time last year when the 10 year gilt yield stood at over 2%, and the governor of the Bank of England was telling us that interest rate rises would come into focus at the beginning of 2016.
Laith Khalaf, senior analyst, Hargreaves Lansdown says: “While all eyes have been on the EU referendum campaign, gilt yields have been slipping, fast. The US Federal Reserve is backing away from interest rate rises following wavering employment data, and in Europe the central bank is pumping billions of euros into the bond market every month in the form of QE, both of which have served to drive yields down.
“The low yield on government bonds paints a pretty pessimistic picture of the global economy, and suggests we are set for an extended period of low or negative inflation, and weak economic performance. The question though is whether one can really trust an indicator which has been so heavily distorted by central bank stimulus measures.
“As an investment, gilts still look like a dicey proposition, offering little in the way of return for taking on a bucket-load of capital risk, if sold before maturity. However the strength of the bond market has consistently confounded professional investors, dating back to the beginning of 2010 when bond guru Bill Gross told us the UK government bond market was sitting on a bed of nitroglycerine; yields at the time stood at 4%.
“In the US there is an old saying that you shouldn’t fight the Fed, and over here you probably shouldn’t fight the Old Lady of Threadneedle Street either. Central banks have been successful in driving yields down, to the consternation of the myriad of respected investment managers who have baulked at investing money at such paltry rates of return. It goes to show sometimes even the best, most rational investors get things wrong.”
The effects of falling bond yields
Bond prices rise when yields fall, which is good for anyone holding a bond fund.
Annuity rates tend to fall after falls in gilt yields, meaning less income for pensioners buying an annuity.
Equities look more attractive by comparison; getting a 3.5% to 4% dividend yield looks increasingly appealing as gilt yields fall.
Pension liabilities increase and deficits tend to widen.