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Gilts Drop on Austerity

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While yields are still near record lows and support lingers for austerity policies in some sectors, those policies are backfiring on the bond market in the U.K., with gilts losing 1.92% in the first quarter, after providing a 17% return in 2011. That is the worst opening quarter for gilts since 1996, and as a result the British government will find itself selling up to 64% more bonds over the next 12 months than it has averaged for the last 10 years as revenues decline.

Bloomberg reported Monday that foreign investors are shedding gilts on fears that the British economy will soon be battling recession rather than growing. Over the three months of Q1, they sold a net 5.9 billion pounds ($9.4 billion) of gilts, compared with Q1 2011, during which there were net purchases of 10 billion pounds.

“The government policies in the U.K. have succeeded in implementing more austerity than in stimulating growth,” Ed Yardeni, president and chief investment strategist at Yardeni Research Inc., told Bloomberg. “Bond markets do well in weak economies, but not if weak economies are weak because they are saddled with huge, unsustainable debt.”

Analysts polled by Bloomberg expect that gilt yields on 10-year notes will rise to 2.55% by the end of 2012, and to 2.75% by June of 2013; that is still below the 10-year average of 4.19%. However, according to Johannes Jooste, a strategist at Merrill Lynch Wealth Management, “It can be a challenge if bond yields rise when the economy is still weak.” Merrill Lynch Wealth Management is currently underweight gilts.

The U.K.’s GDP contracted by 0.3% in Q4 from Q3, according to the Office for National Statistics. The Paris-based Organization for Economic Cooperation and Development said at the end of March that it may have shrunk even more, by 0.4%, in Q1.

While Prime Minister David Cameron has pursued austerity policies to preserve the U.K.’s triple-A credit rating, his policies have been unpopular with voters and with a number of financial professionals as well.

“I was never a great fan of the austerity. We are just not growing fast enough, and that’s got to be a concern for our indebtedness,” said Jim Leaviss, a money manager at M&G Investments, which has about $300 billion in assets. “At times like this, some fiscal stimulus would have actually been quite helpful for the U.K. economy.”

Fitch Ratings in March also changed Britain’s outlook to negative, citing a limited ability for the country to deal with shocks.


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