Bond Watch: why interest rate cut is good news for gilts
Sam Benstead breaks down the latest news affecting bond investors.
2nd August 2024 11:09
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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Interest rates finally fall
The Bank of England cut interest rates yesterday, from 5.25% to 5%, with five out of four of the Monetary Policy Committee members voting for the cut.
In response, bond markets rallied, with the 10-year gilt dropping below 4%, with shorter bond yields also falling as well.
But Benjamin Jones, director of macro research at Invesco, says we should not expect a series of steady cuts in the coming months.
“This cutting cycle is likely to be shallow with intermittent rather than regular cuts as inflationary pressures remain a clear and present danger,” he said, adding that it was a “hawkish” first rate cut from the Bank of England.
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BlackRock, the fund group, likes gilts as it believes lower growth in the UK compared with America will allow the Bank of England more freedom than its US peer to cut interest rates.
While it does not see interest rates returning to pre-pandemic levels, it said: “We do expect more cuts in the UK than in the US over the next two years given the UK’s weaker growth outlook – a view that underpins our long-term strategic preference for UK gilts versus other developed market government bonds.”
But the US leaves rates unchanged
While the Bank of England decided to cut rates this week, the US Federal Reserve kept them on hold.
Nevertheless, the central bank signalled that a rate cut could finally come in September, and now markets are pricing in three cuts this year.
This was interpreted as good news for US bonds, and so yields across the Atlantic also fell. The 10-year US bond yield has now fallen below 4%, similar to that in the UK. It was 4.3% a week ago – rising bond prices cause yields to fall.
Jean Boivin, head of the BlackRock Investment Institute, said the Federal Reserve kept rates on hold as expected, but he now sees a very low bar for a first cut at the next meeting.
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“Chair Powell said they hoped data will show inflation is continuing to move in the right direction and, if so, they would cut by 25 basis points in September,” he said.
However, Boivin notes that there is a lot of data that will be released between now and the next decision, including two payroll reports and two CPI inflation releases.
“Over recent months we’ve seen a run of negative surprises followed by a run of positive surprises – radically shifting the Fed and market narrative. So, we should not be surprised by another surprise,” he concludes.
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