The Labour party’s decisive majority in yesterday’s general election should usher in a period of stability, according to fund managers. Keen to avert a Liz Truss-style melt-down in the bond markets, prime minister Kier Starmer and expected chancellor Rachel Reeves have projected an image of fiscal responsibility.
They seem to have convinced the investment management industry thus far, with several bond managers professing favourable outlooks for the gilt market, including Amundi and PIMCO.
Monica Defend, head of the Amundi Institute, said gilts look attractive in absolute terms and compared to government bonds in the US, Germany and France, where debt-to-GDP dynamics look worse.
“While UK fixed income doesn’t have a huge weight in global benchmarks, there may be a case for international investors to reconsider their strategic allocation given it offers a way to add a good-quality yield with interesting diversification characteristics,” she said.
Mark Nash, Huw Davies and James Novotny, who run absolute return fixed income strategies at Jupiter Asset Management, think Labour’s decisive majority could make the UK appear like a “haven of political stability” in contrast to political upheaval elsewhere.
Gilt yields look cheap compared to other countries that have a weak fiscal position such as France, “so there may well be some flows towards gilts from other challenged sovereign bond markets that continue to have political problems now our election is done and dusted”, they said.
The Jupiter trio are concerned about “the perilous scale of the UK’s twin deficits”, but believe economic growth will be the new government’s “get-out-of-jail free card”.
A better trade deal with the EU and liberalisation of the UK’s planning laws could, if successful, stimulate economic growth and dampen inflationary pressure, they said.
Phil Milburn, co-head of Liontrust’s global fixed income team, agreed that economic growth could give “some leeway to government spending plans”. He thinks growth will come from two areas: unwinding trade frictions with the European Union and “attracting long-term capital to reverse the chronic underinvestment over preceding decades”. Freeing up planning constraints for both business and homebuilding would help, he added.
Nonetheless, David Katimbo-Mugwanya, head of fixed income at EdenTree, said incoming chancellor Reeves has her work cut out “to keep the bond vigilantes at bay”.
“In today’s higher interest rate environment, making inroads into deficit reduction plans will be of the utmost importance lest debt sustainability is called into question,” he noted.
Emma Moriarty, an investment manager at CG Asset Management, is concerned that if Labour embarks on a raft of ambitious policies that require an increase in government spending and therefore bond issuance, it could unsettle bond markets and spark volatility in long-dated gilts.
James Lynch, fixed income manager at Aegon Asset Management, added: “One of the legacies of Liz Truss, who incidentally lost her seat last night, is that there has been much more attention on the relationship between politics, economic policy and the bond markets. But for now, the gilt market will no doubt go back to looking at the latest inflation figures, Bank of England speeches and following US Treasuries for guidance.”
The new government’s first budget in August or September will be “the first real test for the market”, said Liam O’Donnell, head of macro and rates at Artemis and co-manager of the Artemis Strategic Bond fund. He expects Reeves and Starmer to “focus on stability and not play fast and loose with public finances”.
“Despite a more secure political footing, the UK fiscal situation is still weak – so not much will change in the short term. This will provide stability to the gilt market and, with the Bank of England set to cut rates, creates a more supportive environment for UK fixed income,” O’Donnell concluded.
In contrast to Amundi, PIMCO and Artemis, Canaccord Genuity Wealth Management is cautious about UK government bonds.
The wealth manager’s co-chief investment officer Tom Becket said: “We have limited exposure to UK government bonds, keeping the maturity profile of the bonds we own relatively short, ensuring we are not exposed to the volatility of longer maturity bonds, where interest rate, inflation and political risk can bite.”
Becket is more constructive on sterling corporate bonds, which offer comparatively high yields. “Current yields compensate investors properly for the risks they’re taking in lending money to high-quality companies and are considerably higher than they were only a few years ago,” he said.
The change in government is unlikely to have much of an impact on sterling investment grade credit because the market is so global in nature, so spreads tend to be driven by global not domestic factors, said Kris Atkinson, a fixed income portfolio manager at Fidelity International.
“Over half of the sterling investment grade credit market is non-UK-domiciled. Interestingly, this makes the sterling corporate bond market less concentrated (by country) than the global corporate bond market, which is 57% US-domicile,” he said.
Sterling corporate bond spreads remain at the tighter end of their historical range so Atkinson is defensively positioned from a credit perspective, largely for valuation reasons.
Elsewhere, fund managers are keeping a close eye on inflation, which will continue to have an impact on the bond markets and other asset classes, and on the Bank of England’s interest rate decisions.
Trevor Greetham, head of multi asset at Royal London Asset Management, expects inflation to be persistent and therefore recommends an allocation to commodities, which tend to perform well when prices rise.
“The battle against inflation is by no means won and an uncertain geopolitical backdrop, populism and a drop in fossil fuel capacity as we transition to net zero all point to further cost of living surges in coming years,” he said.