WILL UK BOND YIELDS REMAIN LOW?

26.02.2021 During the 2020 Corona virus crisis the yield (interest rate) on the 10 year UK Government Gilt fell to a record low of 0.16%. Will these ultra-low yields persist?

Bonds are multi-year traded loans where the issuer must repay the amount borrowed at a specified future date while also making annual interest payments. They are used in income portfolios to generate a core portfolio income. Their yields (interest rates) are also used as an input into the valuation of other types of investment such as equities.

The combination of aggressive buying of Government bonds by central banks using electronically created money (Quantitative Easing) and strong demand for low risk safe haven assets saw yields on Government bonds, around the world, fall to record lows in 2020. The 10 year UK government Gilt fell to a low of 0.16%, the 10 year US Treasury to 0.51% and the 10 year German Bund -0.68%. The expectation of a return to more normal economic conditions, as Covid vaccinations programmes are rolled out around the world, has prompted a modest rise in government bond yields. This has been most pronounced in the United States as there is an expectation that President Biden will pass a USD 2 tn stimulus package to follow on from the USD 900bn programme that was approved in December. Currently the UK 10 year government Gilt yields 0.80% while the US equivalent yields 1.51%. So, the crucial question is are these conditions likely to persist?

Even prior to the Corona virus crisis bond yields around the world were, from a historical perspective, extraordinarily low. For instance, the 10 year UK Government Gilt traded between 1% and 1.5%. On the savings side it seems that as the wealthy cohort of Baby Boomers have retired this has boosted demand for income producing bonds. As the birth rate peaked in the mid-60s demand for bonds will likely remain high for another decade. On the investment side, as the digital transformation of the economy accelerates, demand for loans, from corporates, to invest in physical capital has diminished. For example, the increased popularity of internet shopping has left many shopping centres increasingly superfluous.

So, the combination of elevated demand for income producing investments and falling physical capital requirements is likely to keep bond yields low for some time. As a result, the emergence of economies from the pandemic and reduced Quantitative Easing is only likely to trigger a modest rise in yields. In the UK we envisage the 10 year Gilt yield returning to a range of between 1% and 2%. For yields to rise beyond this range it would require the UK Government to continue to run massive deficits after the economy recovers and for the Bank of England to desist from the practice of Quantitative Easing.

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This post was written by Robin