Fixed Income and Currency Outlook - August 2017 (Gilts Outperform)
GILTS OUTPERFORM
- Bank of England moderately more hawkish
- Gilt markets continue to perform well overall
- Snap election results in further political uncertainty
Having triggered Article 50 of the EU Treaty, UK Prime Minister Theresa May surprised markets in April by calling a snap general election for early June. Although this had the aim of strengthening her majority before the Brexit negotiation, her Conservative Party
unexpectedly failed to win an outright majority and subsequently had to form a minority government with the backing of Northern Ireland’s Democratic Unionist Party.
The Bank of England kept policy rates on hold during the period. However, towards the end of Q2, markets were surprised that it, along with a number of other central banks, appeared to be more inclined to normalize policy than expected. In June, while the
monetary policy committee voted 5-3 to leave monetary policy unchanged, two of these members were not expected to vote for a rate hike. Chief Economist Andy Haldane (who is considered relatively dovish) later stated that it would be “prudent” to reverse
some of the incremental monetary policy measures that had been introduced in August 2016. Bank of England Governor Mark Carney later stated that some removal of monetary stimulus was “likely to become necessary”.
Gilts continued to outperform US treasuries and German bunds for much of the period. In early June gilt yields reached their lowest levels since early October (when central banks had appeared to reach the limits of monetary policy). However, towards the end
of June, following hawkish pronouncements from central banks domestically and internationally, gilt yields increased sharply to the middle of their ranges for the year.
Political uncertainty has increased following the outcome of the UK general election and a number of plausible political scenarios make forecasting difficult. Gilt yields may justify a higher risk premium, although whether they will significantly increase largely
depends on how foreign buyers react. The Bank of England has indicated that it will look through any transitory increases in inflation as it trends above target. Should economic downside risks become a factor, the central bank will likely maintain its current accommodative stance.
Andrew Wickham
Head of Global Rates and Deputy Head of Fixed Income (London)
https://www.insightinvestment.com/globalassets/documents/recent-thinking/na_fixed-income-and-currency-review-and-outlook-q2-2017.pdf
