Investors Load Up on UK Bonds to Bet BOE Is First to Cut
For investors betting the Bank of England will switch to interest-rate cuts before its peers in Washington and Frankfurt, UK government bonds look like a bargain.
(Bloomberg) -- For investors betting the Bank of England will switch to interest-rate cuts before its peers in Washington and Frankfurt, UK government bonds look like a bargain.
Strategists and fund managers at Jupiter Asset Management, Pictet Asset Management and Candriam say markets are still underpricing the chances of the BOE delivering faster and deeper rate cuts than its major counterparts. While the odds of a reduction at its May meeting are about one in five, market pricing still suggests UK officials will lag behind the European Central Bank.
“The BOE can be the first to cut,” said Luca Paolini, chief strategist at Pictet AM, who predicts gilts will outperform. “Given that we are still pretty much in recession, the UK is probably where you need rate cuts more than elsewhere, maybe even more than Europe.”
Record demand at both of this week’s gilt auctions underscores growing appetite for UK government bonds, with offers for 20-year and three-year debt attracting their highest-ever bid-to-cover ratios.
UK inflation dropped more than expected in February, prompting two of the BOE’s most hawkish policymakers to ditch their preference for hikes. While the economy has technically emerged from recession, PMI data imply only a marginal pace of expansion not far above stagnation.
Yet yields on 10-year UK bonds are almost double the rate on their German equivalentsand the spread between them is much wider than their five-year average.
Jamie Niven, a senior fund manager at Candriam, has been building exposure to potential UK rate cuts since March via five-year sterling swaps, and he’s shorting the pound. Markets are underestimating the extent of BOE easing this year, he says.
“A June cut is pretty likely, in fact I wouldn’t completely rule out a May cut,” he said, noting that the BOE is more “nimble” than the ECB given the smaller size of its monetary policy committee.
To be sure, money-market pricing suggests conviction is still low. The chance of a first quarter-point rate cut from the BOE in June is seen at 70%, compared to around 90% for the ECB. For the Fed, that chance is closer to 50%.
Also the UK central bank is seen delivering fewer reductions in 2024 than its euro-area counterpart — at around 70 basis points and 85 basis points, respectively. The market envisages the US cutting by 65 basis points.
But with the 10-year gilt yield around 4.10% — compared with 2.40% on bunds — big names have been adding exposure.
J.P. Morgan Asset Management increased its overweight UK gilt position over US Treasuries in the past few months, while Newton Investment Management has been running a long position in gilts, which they see as offering better value than bunds.
Cuts are “more immediately required relative to the US, even as medium- to long-dated government bonds are sitting at pretty similar levels,” said Harry Richards, a fixed income manager at Jupiter AM, who’s also been adding to his holdings.
“The gilt market does stand out as looking cheap.”
--With assistance from James Hirai, Anchalee Worrachate and Kriti Gupta.
(Adds details on record demand at gilt auctions in fourth paragraph; JPM, Newton favouring gilts in third from end.)
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