In December 2014 I first posted a blog with the title ‘Where next for gilt yields?’ Following a steep downturn in yields over the next two months I revisited this with Part 2 in February 2015. So now, in October 2015 I think it is time for an update.
To start here is the latest version of my yield data graph going back to January 2009:
- Blue: the yield on over 15 year AA rated bonds
- Red: the yield on over 15 year gilts
- Yellow: Market Implied Inflation as gilt yield minus index linked gilt yield
The direction of the red line in Q4 2014 clearly shows why I wrote the first Blog and pointed out three things – which were:
- Firstly, and probably most importantly, gilt yields show little sign of going up. We haven’t even had much in the way of false dawns. Any spike in yields has quickly leveled off before resuming a downward trend. If trustees and sponsors are waiting for yields to rise, there is no knowing how long they will have to wait.
- Secondly, the yield gap between gilts and AA bonds has been below 1% for the past 17 months. For those trustees who only use high quality bonds in their matching portfolio this means that a 50/50 gilt/bond portfolio is only yielding 3.09% – this is the lowest yield since I started collating the data in January 2009 (when the composite yield was 5.73%).
- Thirdly, the yellow line has been above the red line since they crossed 3 years ago – this means that index linked gilts have had a negative yield for the past 3 years. As at 28 November 2014 this stood at an astonishing -0.66%. This means that a buy and hold strategy on index-linked gilts guarantees a significant real loss against RPI.
So, where are we now?
Whilst yields have recovered slightly since their low point in January 2015 they are still significantly below 3%. There is still little sign of any long awaited rise in yields. If trustees and sponsors were waiting for yields to rise a year ago they are still waiting now.
There has been a slight increase in the credit spread. This is now back out to around 120bps from a low of 80bps in February 2015. This has edged the composite yield on a 50/50 gilt/AA bond portfolio back above 3.0%. The difference is that where this used to be ‘the lowest since I started collating data in January 2009’ it now feels more like a blessed relief. The composite yield had dropped to 2.41%in January 2015.
Finally, we seem no nearer seeing gilts generate a positive real return against RPI. The yield on index linked gilts has been in negative territory for all but 2 months out of the last 46. At their current level of -0.85% there seems little prospect of a return to positive territory in the near future.
In my first Blog I signed off with:
- “The future is notoriously difficult to predict and always has the capacity to surprise”
I think that remains true, so I will answer my original question by saying:
I don’t know; I won’t be guessing; I will be watching. In doing so I hope that this will help me and my fellow trustees manage each of our unique pension schemes in the most appropriate and pragmatic way we can.