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Gilts Go Gangbusters

12 August 2016 by Chris Bowie

On Thursday, two days after the Bank of England failed to buy as many long dated gilts as it wanted to (no I’m not going off on one about liquidity again, but it does illustrate our point), we note a strange technical quirk in terms of gilt cash prices at the long end of the yield curve.

Bearing in mind that gilts, like most bonds, are issued at 100 (or very close to), and usually redeem at the same level, it is interesting to note that two conventional gilts now have cash prices of over 200.  Yes, over 200. Usually these lofty heights within the gilt market are reserved for index linked gilts, where the coupon and principal are uplifted with inflation over time – therefore it is not unusual to see cash prices that high for linkers. But for conventionals?

Anyone buying one of these two gilts, say the 4% of 2060, now, rather than when it was issued about six months after the start of the first round of Q.E. in the UK back in 2009, will see its price come back to par when it matures on January 22nd 2060. I doubt many readers of this blog will still be managing client money in January 2060, but you never know. That aside, buying now means locking in at least a 100 point loss over the life of the bond if held to maturity – and even my mental arithmetic can work out that this is approximately a 50% capital loss. Yes of course you will get lots of lovely 2% coupons every six months over those 87 remaining coupon dates, but you will still be booking a 100 point capital loss.

Near term or even over the medium term, of course these gilts can go higher in price terms. Don’t forget there is a large buyer out there at essentially any price. But longer term, Mark Carney has placed his chips on growth over inflation. Coupled with the weakness in the pound, I am minded to think his wager will pay off and the UK will return to decent and potentially even strong growth eventually. It is just possible that at some point in the next two years, enough growth and inflation may creep into our economy to change these risk-free assets into return-free risk.

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