Bond Bulletin

Bond Bulletin: Gilt-edged chance?

Bond Bulletin
Bond Bulletin
GFICC Investors

Published: 6 days ago

The FQT research framework

Functional factors

Include macroeconomic data (such as growth and inflation) as well as corporate health figures (such as default rates, earnings, and leverage metrics).

Quantitative valuations

Is a measure of the extent to which a sector or security is rich or cheap (on both an absolute basis as well as versus history and relative to other sectors).

Technical factors

Are primarily supply and demand dynamics (issuance and flows), as well as investor positioning and momentum.

With the UK Gilt market coming under duress in recent months, this week’s Bond Bulletin examines whether the re-pricing has created an investment opportunity.

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Fundamentals

UK economic growth continues to be lacklustre. The rise in real incomes has yet to translate to increased consumer spending, while private sector investment remains tepid. After some progress last year, the disinflationary trend has stalled in recent months. Many measures of inflation have stayed stubbornly high, particularly the services component, while the economy has experienced persistently elevated wage growth which is partly attributable to the weaker supply side of the economy. There are additional factors set to limit progress on inflation; along with annual price resets to open the new fiscal year, businesses will have to contend with the hike in employer National Insurance contributions, at least part of which will be passed on to the consumer, and absorb a rise in the national living wage. It is important to note that the UK is in a much different fiscal position to its European counterparts. In her spring statement, Chancellor Rachel Reeves moved to enact spending cuts to fully restore the fiscal headroom that had been eroded by a combination of higher interest costs, a languid economy and lower tax receipts than anticipated. By contrast, Europe has been confronted with a new geopolitical regime. After years of chronic underinvestment, Germany is now in a position to cast off its traditional fiscal conservativism, mobilise its balance sheet towards a programme of infrastructure investment and improved defence capabilities, and establish greater independence.

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Quantitative valuations

The 10-year UK Gilt yield has risen by 38 basis points to 4.7% since the Autumn Budget, reaching a peak of 4.9% in January. Inflation and wage dynamics are more troublesome in the UK than most developed market economies, and remain the primary focus of the Bank of England. In our view, the Bank will gradually normalise monetary policy with two or three interest rate reductions this year, as policymakers gain confidence that the closely watched pay settlements data will decelerate from the current rate of 3.7% to more target-consistent levels, closer to 3.0%. Current market pricing reflects a terminal rate of 3.75%, but there is scope for the Bank to cut interest rates further than the market expects. Calls for government spending restraint in the UK stand in stark contrast to the new-found fiscal largesse in Germany, and this divergence in the path of fiscal policy should drive spread compression between the two markets as Bund issuance surges to finance spending plans.

The 10-year UK Gilt spread over 10-year German Bunds is almost 100 basis points above the 20-year average

The 10-year UK Gilt spread over 10-year German Bunds is almost 100 basis points above the 20-year average

Source: Bloomberg; data as of 26 March 2025.

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Technicals

The technical factors in the Gilt market are more challenging. Bruised in recent years, with the LDI (liability-driven investing) crisis forefront in their minds, some investors have put Gilts on the bench and demand has waned. There was, however, positive news to emerge from the financial year 2025-2026 Gilt remit, as issuance for the forthcoming fiscal year came in lower than projected. This lower issuance was accompanied by a significant reduction in the share of long-dated Gilts in exchange for a large unallocated portion, which affords the Debt Management Office flexibility to issue where demand is strongest. This development is positive for the long end of the Gilt yield curve, where we have observed a decline in structural demand over time, driven by shifts in the pension sector.

What does this mean for fixed income investors?

The concept of core Europe has changed. Fiscal policy shifts in the eurozone have seen typically more conservative economies prepared to deploy capital to stimulate economic growth and contribute to long-term security objectives. In the UK, fiscal policy is constrained by tighter financial conditions and the Bank of England faces a delicate balance between the risks to the economy and inflation. Under the thick shroud of US policy fog and the lingering threat of on-off tariffs, there are also further upside risks to UK Gilt yields. However, investors can use backups to capitalise on attractive entry points and stage into positions, outright or in cross country trades favouring the UK over Germany.

About the Bond Bulletin

Each week J.P. Morgan Asset Management's Global Fixed Income, Currency and Commodities group reviews key issues for bond investors through the lens of its common Fundamental, Quantitative Valuation and Technical (FQT) research framework.

Our common research language based on Fundamental, Quantitative Valuation and Technical analysis provides a framework for comparing research across fixed income sectors and allows for the global integration of investment ideas.



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GFICC Investors

Published: 6 days ago

The FQT research framework

Functional factors

Include macroeconomic data (such as growth and inflation) as well as corporate health figures (such as default rates, earnings, and leverage metrics).

Quantitative valuations

Is a measure of the extent to which a sector or security is rich or cheap (on both an absolute basis as well as versus history and relative to other sectors).

Technical factors

Are primarily supply and demand dynamics (issuance and flows), as well as investor positioning and momentum.