Goldman Sachs and Amundi are showing increasing confidence in UK bonds, a reflection of optimism that the new government will manage the country’s finances responsibly while aiming to stimulate economic growth.
With Chancellor of the Exchequer Rachel Reeves set to unveil her first budget on October 30, bond markets are making a clear bet that the UK won’t experience another fiscal crisis like the one triggered by Liz Truss’s mini-budget in 2022.
According to a Bloomberg report, Amundi, Europe’s largest asset manager, has shifted its exposure away from European bonds to focus on UK debt.
Similarly, Goldman has advised clients to buy gilts ahead of the budget announcement.
BlackRock has also upgraded UK bonds from neutral to overweight, while Legal & General Investment Management and Aviva Investors are adding exposure to UK debt as well.
A bet on fiscal prudence and market discipline
The influx of funds into UK gilts reflects investor confidence that Reeves will balance her budget while tackling the £22 billion hole in public finances.
Although the national debt continues to grow, Reeves is expected to exercise fiscal discipline.
Daniel Loughney, head of fixed income at Mediolanum International Funds, said, “She will want to maintain some kind of perception of fiscal discipline,” signaling why his firm is also overweight on UK bonds.
Part of the optimism around UK bonds is fueled by expectations that the Bank of England will soon begin cutting interest rates more aggressively.
This sentiment strengthened after recent data showed a significant slowdown in inflation. John O’Toole, head of multi-asset investment solutions at Amundi, expressed confidence, stating,
The UK should benefit from slowing inflation and fiscal discipline.
Gilt underperformance won’t last, say strategists
Despite a challenging month for UK bonds, with the 10-year yield climbing over 30 basis points since mid-September, many believe this underperformance will reverse.
Goldman Sachs strategists, including George Cole, remain confident that a “fairly gilt-friendly” budget will help bonds recover.
Meanwhile, BNP Paribas economists expect the government to use the budget as an opportunity to send a strong message of fiscal responsibility, which could ease market concerns.
“Fixed income markets are likely to balk at anywhere near to half of this sum given the impact of issuance on yields,” warned Mark Dowding, chief investment officer at RBC BlueBay Asset Management, highlighting the potential effects of significant borrowing on yields.
Changes to fiscal rules and market expectations
Investors are anticipating some fiscal maneuvering in Reeves’ budget, including potential tax hikes and changes to the self-imposed fiscal rules that currently limit government borrowing.
While some are concerned about moving the “fiscal goalposts,” Sunil Krishnan, head of multi-asset funds at Aviva, reassured investors, saying,
We understand the concerns about moving fiscal goalposts, but unlike the Truss mini-budget, we expect the Office for Budget Responsibility to be an important check on government plans.
One potential move could involve excluding the Bank of England’s balance sheet from national debt calculations, which would free up an additional £16 billion for borrowing.
A more aggressive option could provide up to £67 billion in borrowing headroom, although this would likely cause concern in the bond market.
Citigroup economist Ben Nabarro recently warned of the risk of a “buyers’ strike” if Reeves’ budget leads to borrowing increases of around £50 billion next year, given that the bond market is already dealing with a record supply of debt this year.
Careful balance between borrowing and investor trust
While investors remain cautiously optimistic, they trust Reeves to tread carefully.
Most believe she will increase borrowing modestly to maintain investor confidence.
Barclays Plc echoed this sentiment, suggesting Reeves may even wait until 2025 to adjust the fiscal rules, allowing more time for a proper assessment.
Moyeen Islam, a rates strategist at Barclays, remarked, “To have had one gilt crisis triggered by proposed fiscal expansion might be regarded as a misfortune, but to have two will look like carelessness,” as he recommended buying gilts over German bonds.
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