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Are gilts in buying territory?

Past performance does not predict future returns. You may get back less than you originally invested. Reference to specific securities is not intended as a recommendation to purchase or sell any investment.

The rate of inflation is still at elevated levels and expectations are that it will rise further in the UK before it reaches its peak. Despite this, we believe there will be fewer increases in interest rates than is priced into markets and there are now some selective buying opportunities among UK gilts.

Inflationary pressures have been building globally since economies reopened from 2020’s lockdown measures, leading to supply chain crunches amid a resurgence in demand. But bond yields only really moved materially higher once we hit 2022.

The UK 10-year gilt yield increased by 80 basis points (bps) over the course of 2021, and were flat in the fourth quarter. In 2022, however, they rose by around 170bps to reach a mid-June peak of 2.65%, before falling to just around 2.0% currently.

The reason for this delayed reaction is twofold: central bank inflation denial and the war in Ukraine.

The failure to raise rates earlier than December 2021 looks to be a major policy error, with the BoE now facing the prospect of enacting further rate hikes against a backdrop of falling growth. History is against them on this front; the Bank of England has never before undertaken a rate hiking cycle at same time as growth is slowing sharply and a technical recession (two consecutive quarters of contraction) is possible. Indeed, this is the general rule around the world, with the exception of the US Federal Reserve’s 1979 inflation-fighting bout under Paul Volcker.

Ultimately, we do not think the BoE will be able to pursue tightening to the extent the market is currently pricing in. Futures markets are currently pricing in 125 basis points of tightening from the current base rate of 1.75% up to 3.25% by early 2023.

While we think rates will go higher, we expect rates to peak below 3.0% due to a realisation that higher interest rates are likely to be a pretty ineffectual tool in this economic environment. Normally, higher rates would put the brakes on demand growth by increasing the cost of money, which in turn would reduce ‘demand-pull’ pressures (where demand is higher than supply, pulling up the cost of goods). However, current inflation is largely of the ‘cost-push’ variety (where a supply shock raises prices, leading to reduced demand) so addressing demand-side conditions will have limited impact.

Inflation is at its worst in non-discretionary items and those impacted by supply shocks, with soaring energy costs being the most notable example. While higher interest rates may help take some heat out of the labour market and lower the risk of a price-wage spiral, the BoE will be very wary of further undermining disposable income for many in society by making it even more difficult to afford the essentials. Further tightening would also risk damaging particular sectors of the economy such as retail and hospitality that have already been suffering as a result of Covid restrictions.

Our base case is that the BoE stops short of taking rates to 3.0% but accompanies further hikes with rhetoric which is aimed squarely at taming the risk of big second-order effects in terms of wage rises.

So what does this mean for our funds’ positioning? Are UK gilts now a buy? We think they are, although not across the curve.

We have been structurally short duration versus the benchmark for a number of years, but the better value implied by rising gilt yields has led us to reduce the scale of this underweight to rates risk this year.

The UK 10-year yield is currently around 2.0%, and we expect it to stabilise in this range. While we plan to stay moderately short duration at current levels, we will aim to manage this quite actively rather than implement a more structural position. Were yields to rise to the 2.25% - 2.50% range, we would further reduce our duration short position. If, however, gilts rallied and the yield pushed back to 1.50% - 1.75%, we would increase the underweight to duration.

We will also be targeting parts of the yield curve that we think will prove most mispriced if, as we predict, there are fewer rate hikes coming than the market expects. The short end of the curve tends to be more policy sensitive, so we favour 2 to 3-year gilts where we expect yields to fall rate hikes are be priced out over time. By contrast, we are underweight the long-end as we think 30 year gilts still do not price likelihood of a sustained period of 2.0% - 2.5% inflation. 

Understand common financial words and terms See our glossary

Past performance is not a guide to future performance. The value of an investment and the income generated from it can fall as well as rise and is not guaranteed. You may get back less than you originally invested.

The issue of units/shares in Liontrust Funds may be subject to an initial charge, which will have an impact on the realisable value of the investment, particularly in the short term. Investments should always be considered as long term.

Some of the Funds managed by the Sustainable Future team involve foreign currencies and may be subject to fluctuations in value due to movements in exchange rates. Investment in Funds managed by the Sustainable Future team involves foreign currencies and may be subject to fluctuations in value due to movements in exchange rates. The value of fixed income securities will fall if the issuer is unable to repay its debt or has its credit rating reduced. Generally, the higher the perceived credit risk of the issuer, the higher the rate of interest. Some Funds may invest in derivatives. The use of derivatives may create leverage or gearing. A relatively small movement in the value of a derivative's underlying investment may have a larger impact, positive or negative, on the value of a fund than if the underlying investment was held instead.


This is a marketing communication. Before making an investment, you should read the relevant Prospectus and the Key Investor Information Document (KIID), which provide full product details including investment charges and risks. These documents can be obtained, free of charge, from www.liontrust.co.uk or direct from Liontrust. Always research your own investments. If you are not a professional investor please consult a regulated financial adviser regarding the suitability of such an investment for you and your personal circumstances.

This should not be construed as advice for investment in any product or security mentioned, an offer to buy or sell units/shares of Funds mentioned, or a solicitation to purchase securities in any company or investment product. Examples of stocks are provided for general information only to demonstrate our investment philosophy. The investment being promoted is for units in a fund, not directly in the underlying assets. It contains information and analysis that is believed to be accurate at the time of publication, but is subject to change without notice. Whilst care has been taken in compiling the content of this document, no representation or warranty, express or implied, is made by Liontrust as to its accuracy or completeness, including for external sources (which may have been used) which have not been verified. It should not be copied, forwarded, reproduced, divulged or otherwise distributed in any form whether by way of fax, email, oral or otherwise, in whole or in part without the express and prior written consent of Liontrust.

Jack Willis
Jack Willis
Jack Willis joined Liontrust as part of the acquisition of ATI in April 2017. Jack started his career on the Alliance Trust Management Training programme in September 2014 and completed an MSc in Finance and Investment (Distinction) at the University of Leeds.

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