Budget 2024: Bond managers downplay gilt market volatility

She also confirmed a change to the government’s fiscal rules, moving from a net debt to net liabilities approach, which has allowed an increase in borrowing through the gilts market.

The government plans to issue £297bn worth of gilts for the 2024-25 financial year, an increase of £19.2bn on its previous plan.

Issuance is set to fall to £256.5bn in 2025-26 and £233bn in 2026-27.

The yield on 10-year gilts rose to 4.39% yesterday (30 October) and had fallen slightly to 4.36% this morning. This is up from 3.76% as recently as 16 September, and is the highest since the end of May this year.

The rise may provide a further boost to defined benefit pension schemes by reducing liabilities.

‘Relief’ for Treasury

James Lynch, fixed income investment manager at Aegon Asset Management, said that, while gilts outperformed other markets on the day of the Budget announcement, longer term the asset class had been tracking in line with US Treasury bonds in the lead up to the November presidential election.

“There is no getting away from the fact that the Truss budget of 2022 has had a lasting impact on the Treasury,” Lynch added. “It was the start of a very odd period in UK politics that ended the career of a chancellor and a prime minister.

“To deliver a budget that included large increases in tax, spending, investment and gilt issuance and to have no negative impact on the market will be a relief to the chancellor and the Treasury. Perhaps the gilt market can finally put to the Truss issue behind it once and for all.”

Ian Mills, partner and head of defined benefit (DB) endgame strategy at Barnett Waddingham, added that while the memory of the infamous mini-Budget was “still fresh”, Reeves had taken steps to reduce the likelihood of surprises that might trigger excess market volatility.

“DB schemes and their asset managers have learnt their lesson - they generally went into this budget with far higher targeted levels of liquidity than they did in 2022,” Mills said. “In short, fears of a repeat of the 2022 gilt market crisis are not justified.”

Systemic risks ‘low’

Chris Arcari, head of capital markets at Hymans Robertson, said: “The market will need to recalibrate for materially higher near-term government expenditure and potential rise in businesses’ labour costs, but we believe the systemic risks to the market are low.”

Jason Borbora Sheen, portfolio manager at Ninety One, said he expected gilt investors’ focus to “return to cyclical growth and inflation dynamics”.

“With rates still in restrictive territory, we continue to expect interest rates to be cut, with the Bank of England moving toward a sequential pace,” he said. “Inflation continues to show signs of softening – including services inflation, private sector regular pay growth and the labour market.”

Peder Beck-Friis, economist at PIMCO, said the Budget gave “no reasons for us to question the fiscal credibility in the UK”, and volatility in gilt prices was likely exaggerated by “technical factors”.

“We continue to like gilts,” he continued. “We expect the market to, over time, shift its attention away from fiscal to the underlying macro drivers, including softening inflation.

“Tight fiscal policy should weigh on growth and inflation ahead – and, over time, we expect the market to price in a lower terminal rate for the Bank of England’s cutting cycle.”

Declining demand?

Barnett Waddingham's Mills also highlighted the changing nature of DB schemes, which he said could also have an impact on gilt yields.

“For the last 20 years or so UK DB schemes have been buying gilts at almost any price,” he said. “They are, however, now generally very well-funded and own pretty much all the gilts they will ever want to buy.

“The danger for the Treasury here is that when a DB scheme buys out, most of those gilts ultimately are sold, either by the scheme to pay a cash premium or by the insurer as they redeploy assets into higher-yielding investments.

“This could apply further upward pressure on yields from declining pension scheme demand over the next few years. Our view is that this will be felt most keenly in the long end of the curve and especially in the index-linked market where there are few other natural buyers.”

Further reading

Budget 2024: ‘Devil is in the detail’ of tax change implications (30 October 2024)

How are DB schemes changing the gilts market? (7 March 2024)

Learning lessons from the 2022 gilts crisis (5 October 2023)