Bond Watch: using bonds to beat savings accounts
Sam Benstead breaks down the latest news affecting bond investors.
13th September 2024 09:22
by Sam Benstead from interactive investor
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Welcome to interactive investor’s ‘Bond Watch’ series, covering the latest market and economic news – as well as analysis – that is relevant to bond investors.
Our goal is to make the notoriously complicated world of bond investing simpler, by analysing the week’s most important news and distilling it into a short, useful and accessible article for DIY investors.
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NS&I cuts savings rates
National Savings & Investments (NS&I) has cut its fixed-rate savings rates, which increases the appeal of investing in UK Treasury Bills, which are short-term savings instruments provided by the UK’s Debt Management Office.
NS&I’s two-year Guaranteed Growth Bonds now pay 4.25% a year, down from 4.6%, and its three-year Guaranteed Growth Bonds now pay 4%, down from 4.35%.
Meanwhile, easy-access NS&I accounts pay around 4%, and its cash ISA product pays 3%.
This is below the rates on offer from UK T-Bills, which ii offers access to via regular auctions.
For example, TradeWeb data shows that T-Bills maturing in six months yield about 4.8%, giving investors an attractive fixed return that can be owned inside ISA and SIPP wrappers. Three-month T-Bills pay just under 5% on an annualised basis.
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T-Bills are zero coupon bonds. They are issued at a discount to a £100 par value, and mature over a shorter time period than gilts: one month, three months and six months.
The investment return comes solely from the difference between the price the government sells to investors at (less than £100) and the redemption price the government pays back (£100) on maturity.
These returns show the appeal of using debt markets as a tool for cash savings. It is particularly valuable at the moment as there is an inverted yield curve, whereby the government is paying more to borrow over periods below two years than between two and 10 years.
Money market funds, where annualised returns are closely linked to the Bank of England base rate, also look attractive currently compared with savings accounts.
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Yields are just over 5% on funds such as Royal London Short Term Money Market , L&G Cash Trust and Fidelity Cash.
The pushback is that interest rates are forecast to fall to 4.5% by the end of this year and to 3.75% by the end of 2025, so locking in a longer-term interest rate, even if yields are lower than shorter-term fixes, may deliver a higher total return.
US inflation falls to 2.5%
Inflation in the United States fell to 2.5% in August, down from 2.9% in July. While the headline number came in lower than economists expected, there was a month-over-month rise of 0.3% in “core” inflation, which strips out volatile components, such as food and energy. This equated to an annual core CPI number of 3.2%.
Nevertheless, investors were unfazed by the inflation numbers and bond yields only edged higher. This was because investors dialled back bets of a 0.5% interest rate cut in America in the coming September meeting. The most likely outcome next week is a 25 basis points cut.
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Preston Caldwell, US economist at data firm Morningstar, said: “The inflation data should diminish the odds of a 0.5% Federal funds rate cut this month, but we had already thought that was unlikely. By contrast, it does nothing to diminish the odds of a 0.25% cut.
“Core CPI’s uptick compared to a month ago was driven entirely by housing. Core CPI excluding shelter was up 0.09% month-on-month, and it has increased at a 0.3% annualised rate in the past three months. Housing is the sole remaining driver of our inflationary worries.”
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