Recently, bond prices generally have had a hard time, but UK Gilts have been hit harder than most; yields on the 10 Year Gilt have risen by 40 basis points (0.4%) in the last month, versus +35 basis points for US Bonds of the same maturity.
This might be seen as strange as both nations Central Banks are now pondering ending their QE programmes and, in the case of the BOE, openly talking of interest rate rises in early 2022.
The 10 Year Gilt future has fallen from over 129 in late August to 123.59 as of 21/10/21. Short Sterling Futures, which are used to hedge short term interest rate moves, are now implying a rise of 0.75% by September 2022, which has also boosted Sterling.
But how realistic is this?
A heavily indebted nation, (which will be made more so if the panoply of proposed Green related investments are actually made) will struggle to sustain higher rates in what is increasingly looking like a stagflationary environment.
The most likely outcome of a rate rise at this stage would be to trigger a recession, which would be Gilt bullish, as interest rates would most likely need to fall once again.
The authorities already know this, of course and it is possible that they will follow the strategy of Mark Carney, which was to talk tough on rate rises, but never actually deliver- the 4 cent rise in GPB versus the US Dollar will have done a lot of the anti-inflationary work for the BOE in any event.
The key level to watch on the 10 Year Gilt future is the low point (123.44), made on 11th October.
It is often the case that a downside break of that point (a false break) will lead to a strong bounce higher, possibly to as high as 125.25, the last peak.
Stop losses should be placed below 123, to allow some “breathing room”, but should be raised to break even as soon as is practical.
It is important to stress that the long-term trend in interest rates is clearly up, so this idea is a counter trend trade; new lows look likely in the medium term, as investors generally appear to be expecting a “non-transitory” inflation rise, amid numerous supply chain disruptions and an increasingly tight labour market, which is seeing significant wage concessions being made by firms to their employees.
A wage-price spiral is not out of the question in future months, so it is unlikely that bonds can see sustained gains until inflation is under control.
In the next few days or so, an oversold bounce is highly likely, which in the medium term provides an opportunity to go short at better levels.