Funds See ‘Violent’ Drop in UK Bonds as Opportunity to Buy Cheap

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(Bloomberg) — A dramatic selloff in the UK’s bonds since conflict broke out in the Middle East is a buying opportunity for a handful of investors willing to brave the volatility.

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Fund managers at the likes of Russell Investments, Marlborough Investment Management and Nedgroup Investments have grabbed exposure to gilts in recent days, during wild gyrations that drove short-term yields to the highest in nearly a year.

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The “violent” and “exaggerated” move in gilts offered a chance for Russell’s multi-asset team to pick up 10-year futures on Monday, said Van Luu, the firm’s global head of FX and fixed income solutions strategy. He said the UK’s bonds should be moving in line with peers, but instead have been worse hit.

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“The inflationary impact of this Middle East situation in the short term should be similar across economies,” Luu said. “So there’s no reason why gilts should behave significantly differently from Treasuries or bunds.”

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Gilts have taken a bigger beating on speculation that higher energy prices will hit the UK economy harder than other major countries, given that inflation remains a perennial concern in Britain. Short-dated notes saw the brunt of selling — and the widest ranges since 2023 last week — as traders flipped to bet on Bank of England interest-rate hikes rather than cuts.

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For Marlborough Investment Management, the underlying picture in the UK still points to a weakening labour market, given the growth impact of the oil price spike. This led it to buy 10-year gilts on Friday, which it held through Monday’s selloff.

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Money market pricing for 20 basis points of BOE hikes “was just plain wrong in my opinion,” said fund manager James Athey.

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That has since pulled back, with swaps now pricing rates being held steady this year. Still, gilts renewed their losses on Wednesday, taking the increase in 10-year yields this month to around 40 basis points. That’s nearly double the rise in US and German equivalents.

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“Gilts looked great in short-term relative value to the US and Germany, given the recent under performance,” said David Roberts, head of fixed income at Nedgroup, who moved from neutral on gilts in his global bond fund to “double weighted” last week.

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If oil prices fall back to around $80 a barrel by May, the BOE will be able to “look through” the spike and “may indeed be more tempted to cut,” he said.

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Either way, further swings are likely as the conflict continues, with a market gauge of expected volatility rising to the highest since 2023 this week.

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“There comes a point where prices are attractive enough to step in even without necessarily having more information about how this pans out,” Marlborough’s Athey said.

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—With assistance from James Hirai and Greg Ritchie.

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