(Bloomberg) -- Legal & General Investment Management is shifting from US Treasuries and German debt into the UK’s bonds as it sees the Bank of England catching up with other central banks in slashing interest rates.
The UK’s biggest asset manager has been building up an overweight position in gilts after being neutral for months, its head of macro asset allocation Christoper Jeffery said in an interview. This reflects a view that UK bonds will rally as markets are wrong in expecting that its economy will strongly outperform the US and the euro zone.
It’s a bet that goes against the recent underperformance of UK bonds, which has driven the yield premium investors demand versus Germany and the US to the highest in over a year in October. While markets expect the BOE to go slower on cuts, Jeffery thinks the UK’s economy will need more stimulus.
“That divergence that we’re seeing between pricing of the central bank policy path over the next 12 months between the UK and and other economies, we think is likely to reconverge,” Jeffery said. That “will then drive gilt yields down relative to Treasuries and bunds.”
Wildly see-sawing bets on central bank policies have been driving global bonds this year, as investors try to judge just how fast policymakers will cut now that inflation has eased. The BOE, European Central Bank and the Federal Reserve are all expected to keep reducing borrowing costs in the coming months, though markets are pricing in 114 basis points of BOE cuts by the end of 2025, around 20-30 basis points less than the other two.
While the UK’s inflation has proved more stubborn, Governor Andrew Bailey has hinted the BOE could become a “bit more aggressive” in its approach. Even so, investors are eyeing the prospect of the new Labour government tweaking fiscal rules to enable more borrowing to spur economic growth in its annual budget at the end of this month.
Jeffery acknowledged that the UK economy has been faring better than Europe, particularly in manufacturing, which has taken a “terrible” hit on the continent. But he argues that markets are wrong in betting that this outperformance will continue, given how closely economies are integrated through trade and inflationary drivers.
The rise in gilt yields has outpaced other bonds, he said. UK 10-year yields are up a hefty 24 basis points so far this month to 4.24%, versus a 16 basis-point rise for German bunds.
“So if this effect were to unwind, we would expect it to outperform those markets by the same sort of magnitude,” he said.
--With assistance from James Hirai.
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