UK Funds Snap Up Gilts in Bet That Markets Have BOE All Wrong

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(Bloomberg) — Two of Britain’s biggest asset managers are buying UK government bonds, convinced the market has misjudged how the Bank of England will respond to the war in the Middle East. 

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Legal & General and Aviva Investors both added exposure to gilts this month as surging energy prices prompted traders to abandon bets on interest rate cuts and wager instead that resurgent inflation would force a hike.

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Prior to the war’s outbreak, investors expected the central bank to cut interest rates twice this year, reducing borrowing costs by a total of 0.5 percentage points. Now, swaps reflect a 50% chance of a hike. 

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The rapid shift in expectations helped drive a selloff in UK government bonds, and create a buying opportunity for contrarians. Yields on two-year gilts — the most sensitive to changes in monetary policy — have risen over 0.5 percentage points since the start of the conflict to roughly 4%.

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“I don’t know whether they’re still likely to cut, but they’re unlikely to hike,” said Christopher Jeffery, head of macro strategy within the asset allocation team at Legal & General. 

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His thesis revolves around the state of the UK labor market and the economy, which failed to grow in January. Rates are also a lot higher than in 2022, when Russia’s invasion of Ukraine fanned inflation and the Bank of England increased borrowing costs.

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“The unemployment rate has been creeping up for the best part of a year and a half, the labor market backdrop — and the starting point of rates — is very different to 2022,” said Jeffery.

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Other money managers have made a similar assessment. Russell Investments, Marlborough Investment Management and Nedgroup Investments have also braved the volatility, boosting their exposure to gilts amid the selloff. 

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Legal & General bought UK bonds at the belly of the curve, while Aviva added a position in one-year one-year forwards, a bet that two-year rates will fall. 

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“We still think the path is for lower rates over the next 12 to 18 months,” said Steve Ryder, senior portfolio manager at Aviva, pointing to economic and labor market weakness. “Policy rates are restrictive in the UK and that’s different to a lot of other markets.”

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Investors have not yet heard much on the energy-price shock from Bank of England officials, who are required to avoid speaking engagements and commentary ahead of policy meetings. The central bank will release its latest decision on Thursday, the same day as employment data. Gilts rallied across the curve on Tuesday, with two-year yields falling as much as eight basis points to 4.02%. 

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JPMorgan Asset Management said the Bank of England is likely to have a higher bar for rate hikes than some other central banks, in part because the labor market has softened. “I don’t think they are going to need to hike but it certainly delays the disinflation process,” global rates portfolio manager Kim Crawford said on Bloomberg TV.

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