Follow this topicFollow this topic Knowledge » The economy

Gilt market won't crash in 2013

Ed Bowsher
by Lovemoney Staff Ed Bowsher on 04 February 2013  |  Comments 5 comments

Some pundits are predicting a crash in the bond market this year. I'm not convinced.

Gilt market won't crash in 2013

You may have read comments in the press that there’s a ‘gilt bubble.’ In other words, gilt prices are way too high, and there’s a strong chance that the market will collapse this year. That’s the theory anyway.

A collapse in the government bond market would affect most of us – it would lead to higher interest rates on long-term mortgages, push up annuities for new retirees and reduce the value of many peoples’ investments and pension pots.

Why?

So why do some people think there’s going to be a crash?

1. They look expensive on many measures
As I write the yield on ten-year gilts is just 2.08%. So if you bought a ten-year gilt today, you’d only get an annual income of 2.08% for the next ten years, plus the face value of the bond at the end of the term.

Obviously just over 2% a year isn’t a great return, especially when inflation is more like 3%. What’s more, the yield on ten-year gilts was around 5% in 2008. So gilt prices have gone up a lot, yields have fallen, and gilts look expensive on many measures.

2. Europe looks more stable

The Eurozone doesn’t appear to be on the verge of collapse anymore, although I wouldn’t rule out a collapse in the longer term.

Some investors bought gilts in 2010/11 because they wanted a ‘safe haven’ from storms elsewhere. Now things have calmed down a little in the Eurozone, some investors may sell gilts and take a bit of a risk with European bonds or even shares.

3. The Bank of England isn’t buying at the moment

Since Quantitative Easing (QE) began in 2009, the Bank of England has created £375 billion in new money and used it to buy gilts. However, QE is on hold at the moment, so the Bank isn’t making big purchases of gilts. If a big buyer disappears from a market, you’d normally expect prices to fall – all other things being equal.

Not convinced

But I’m not convinced that we’re going to see big falls in gilt prices this year.

One of the biggest drivers of gilt prices has been gloom about the economic prospects for the UK. We all know that the Bank of England’s base rate is very low at 0.5%, and if you think that the rate will persist at that level for years to come, a 2.08% return on gilts doesn’t look so crazy after all.

I can’t see any sign of a sustained economic recovery so the base rate will probably stay at 0.5% for at least another year, probably longer. And remember our sluggish economy isn’t the only reason the base rate is so low. The Bank of England is also trying to make life easy for our troubled commercial banks. That will continue for a while yet.

And the other point is that there is still a significant overseas demand for gilts. In fact, overseas investors bought £15.4 billion more bonds than they sold in December. That’s the highest figure for net purchases since November 2011 and the third highest since 1982.

Now you might say there’s a risk that the markets will lose confidence in the UK government’s ability to repay its debt. And it’s true, if bondholders fear they won’t get their capital back when bonds mature, they’ll sell now regardless of the economic outlook.

But the reality is that the risk of a UK government default is minuscule. As the UK has control of its currency, it can always create more money if necessary, and we can also benefit from a potential devaluation if necessary.

To be clear, a modest fall in prices is possible, and I’m certainly not going to buy any gilts at current prices. I’m investing for the long-term and I need to make more than 2% a year if I’m going to build a sizeable investment pot for my retirement.

But I’m suspicious of the conventional wisdom that a big fall will happen this year. I can’t really see what could trigger a big fall, and I think that a weak economy, a low base rate, and continuing overseas demand will put a floor below prices.

If…

So if I’m right, what does it mean for ordinary folk?

Well, it’s bad news if you’re planning to buy an annuity anytime soon. Low gilt yields lead to poor incomes from annuities.

It’s also a problem for the trustees of old-fashioned final salary pension schemes. For technical reasons, if gilt yields are low, a pension fund’s deficit increases. This will encourage employers to curtail any remaining final salary schemes.

However, high gilt prices aren’t bad for everyone. You might own some gilts yourself or have money in a fund that is wholly or partly invested in gilts. If you’re in that boat, I don’t think 2013 is going to be a particularly bad year for you.

More on investment and the economy:

A new rival to Hargreaves Lansdown
The cheapest index trackers
Six great reasons to choose an index tracker
When the recovery comes, you better be ready for it

Enjoyed this? Show it some love

Twitter
General

Comments (5)

  • nickpike
    Love rating 309
    nickpike said

    Watch 3 or 4 or these, this guy is in the know.

    http://rt.com/programs/keiser-report/

    Then watch this,

    http://www.parliamentlive.tv/Main/Player.aspx?meetingId=12271

    Mervyn King painted a very gloomy picture and his crony said that the banks have no liquidity and wil need another bail out, and would be a 'big number'. they are reporting back in March.

    Europe quiet? Just read last week unemployment was up and today government bond yields had increased. Europe is far from 'over'.

    The BoE raised more than 375 bn with the addition of some fake interest at about 37 bn. There is serious talk at present that QE is a mistake and it is be talked down. Only QE is keepin us going, and it's damage in other areas is obvious.

    Report on 04 February 2013  |  Love thisLove  1 love
  • jonnie2thumbs
    Love rating 107
    jonnie2thumbs said

    As the UK has control of its currency, it can always create more money if necessary

    Like the Weimar Republic ?

    In 1919, one loaf of bread cost 1 mark; by 1923 the same loaf of bread cost 100 billion marks.

    great!

    we can also benefit from a potential devaluation if necessary.

    yes please - devalue my currency

    Report on 04 February 2013  |  Love thisLove  0 loves
  • Arblaster
    Love rating 43
    Arblaster said

    @nickpike

    Thanks for the links. I think Max and Stacy, who I think have recently been married, have moved over here from France just to be present when the gilt market collapses. I am not so sure. Yes, I agree that it is going to collapse big time, and I am looking forward to it. It is only a question of when. These markets can go on for years, then something insignificant happens in some remote corner of the world - the so-called black swan event - then suddenly everything is collapsing round your ears.

    I have heard that there have also been increases in the yields of US Treasuries of late. My own personal opinion, based on whispers that I have heard, is that somewhere along the way Bernanke intends to yank up interest rates big time. Again, it is only a matter of when.

    Report on 04 February 2013  |  Love thisLove  0 loves
  • Mike10613
    Love rating 626
    Mike10613 said

    Gilts are no longer a safe investment, but the super-rich have so much money they don't know what to do with it. They should invest in British industry and commerce but they are greedy and scared. The traders are playing it safe on their behalf. The gilt market will crash, it's just a matter of time. Ponzi schemes always crash in the end.

    Report on 05 February 2013  |  Love thisLove  0 loves
  • yocoxy
    Love rating 152
    yocoxy said

    @Nick

    Do you have any good news for us? In all the years I've been visiting this site I've only ever seen you post predictions of gloom.

    I hope there are bright moments in your life.

    I find it more heartening to make the best of the situation I'm in, look for opportunity and enjoy life rather than read articles affirming my worst fears and then spread the gloom.

    I find that in general a positive view of life also leads to greater success which itself brings more opportunity. It's an upward spiral rather than the Daily Mail > conspiracy blog > depression > Daily Mail > etc > etc > downward spiral that some here seem to be caught up in.

    Report on 05 February 2013  |  Love thisLove  0 loves

Post a comment

Sign in or register to post a reply.

Our top deals

Credit card
company
Balance transfers rate and period Representative
APR
Apply
now

Barclaycard 31Mth Platinum Visa

0% for 31 months (2.99% fee) Representative 18.9% APR (variable) Apply
Representative example: Assumed borrowing of £1,200 for 1 year, at a Purchase Rate of 18.9% (variable), representative 18.9% APR (variable). Credit available subject to status. A Balance Transfer fee of 3.5% will be applied, then reduced to 2.99% by a refund (terms and conditions apply). Plus an additional £20 fee refund on balance transfers over £2000.

Barclaycard 30Mth Platinum Visa

0% for 30 months (2.89% fee) Representative 18.9% APR (variable) Apply
Representative example: Assumed borrowing of £1,200 for 1 year, at a Purchase Rate of 18.9% (variable), representative 18.9% APR (variable). Credit available subject to status. A Balance Transfer fee of 3.5% will be applied, then reduced to 2.89% by a refund (terms and conditions apply). Plus an additional £20 fee refund on balance transfers over £2000.

MBNA 30Mth Platinum Credit Card Visa

0% for 30 months (2.89% fee) Representative 18.9% APR (variable) Apply
Representative example: Assumed borrowing of £1,200 for 1 year, at a Purchase Rate of 18.9% (variable), representative 18.9% APR (variable). Credit available subject to status.
W3C  Thank you for using The Four Horsemen of the Apocalypse