Bond prices to fall as buy-back ends

Investors seeking income are being advised to sell gilts now that the Bank of England has suspended its gilt buy-back initiative and held interest rates at 0.5 per cent.

The government’s quantitative easing programme (QE) may be reinstated if conditions in the wider debt markets degenerate.

However, the expectation is that gilt prices will fall while yields rise in the near term as demand from buyers diminishes in the coming weeks. Corporate bonds are also likely to suffer some knock-on effects. As a result, the capital value of bond portfolios could take a hit, advisers warn.

“The simple impact is that holders of gilts and corporate bonds are likely to see the capital value of their investment fall in value to reflect the new supply and demand dynamics,” said Jason Butler, an adviser with Bloomsbury Financial Planning. “However, this is unlikely to happen in one big bang, but in fits and starts over several months.”

Nick Gartside, manager of Schroders’ Strategic Bond fund, predicts yields on 10-year gilts – which hover around 3.9 per cent – will rise to 4.5 per cent and hold steady for a period. In a sign of Gartside’s uncertainty, Schroders’ strategic bond fund is shorting gilts. “The end of the QE programme is generally a negative for investors,” Gartside said.

While neither conventional gilts nor the inflation-proofed variety look attractive at current levels, corporate and high-yield bonds and emerging market debt are more appealing, according to advisers.

Five-year Indonesian bonds yield 9 per cent while five-year Mexican bonds offer a 7 per cent return, according to Gartside. Debt issued in US dollars by TAM Brazil airlines pays 10 per cent, he notes.

“High-yield and emerging market debt is risky, but some of the yields are pretty good,” he argued. “You have to get comfortable with the default risk, and I think that’s lower now,” said Gartside.

Demand may improve if gilt yields approach 5 per cent. And traditional buyers – such as pension funds, banks and insurers – are expected to remain loyal to the market. “There will be gilt buyers at the right levels,” Gartside added. “To my mind, 5 per cent is a pretty good return. The current level of 3.9 per cent is low given that inflation is 2.9 per cent.”

Pension funds, in particular, are keen to see gilt yields rise as the QE programme has increased their liabilities. “We hope that the suspension of QE will raise yields, and so reduce scheme deficits,” said Joanne Segars, chief executive of the National Association of Pension Funds. “We want the government to play its part in supporting pension funds and help stem the tide of scheme closures by issuing more long-dated and index-linked gilts. This will help bring the stability that schemes need.”

Ian Robinson of F&C predicts that volatility will become a permanent feature of the debt markets following the BofE’s move. “The risk is that the end of QE will crowd out the market for other issuers and make it harder for everyone else to compete,” he said. “Supply will continue to be there, but demand will be much more lumpy and only come at certain times.”

The Bank chose to suspend QE after buying back £200bn in gilts, but it could be reinstated. “This is a sensible approach as there is uncertainty about how effective QE has been and how its impact will work through the economy, ” said Adrian Lowcock, an adviser at Bestinvest.