Government bond yields fall to unprecedented lows
Month in brief
Significant falls in government bond yields lead to large increases in the liabilities of a typical scheme
Equity markets fall as US-China trade conflict intensifies
Perceived likelihood of a no-deal Brexit increases
Global government bond yields dropped to unprecedented lows over the month. Both economic and political factors contributed to these large decreases, which have seen the yield on a 30-year US government bond fall below 2% for the first time; the issuance of a 30-year German bond that offers no interest payments; and the real yield on UK index linked gilts fall to -2.2%. Further insight on the significant falls experienced by gilt yields yearto- date can be found in our one-off UK gilt market – special update.
Sterling remained weak and volatile against both the Dollar and Euro over the month as perceived likelihood of a no-deal Brexit on October 31st increased. Against much opposition, Boris Johnson announced the prorogation of the current parliamentary session, which has kick-started a period of substantial political uncertainty as we get closer to the Brexit deadline.
His calls for a fundamental reworking of the terms of Britain’s withdrawal have so far been rejected by the EU. The UK economy contracted for the first time in almost 7 years with output falling 0.2% over the 3 months to June. The main cause is thought to be the unwinding of the large stockpiles UK companies built up in the run-up to the original Brexit deadline of March 29. Brexit uncertainty and a backdrop of weaker global growth have also weighed on output. UK equities fell over the month as a result.
Elsewhere around Europe, industrial production and exports in Germany declined leading the Bundesbank, Germany’s central bank, to warn that Europe’s largest economy is likely to tip into recession. More globally, the impact of Hong Kong’s political crises has been felt by its stock market, as its gains for the year have been wiped out amid conflicts between the police and protestors.
Gilts were the strongest performer over the month
One Month to 31 August 2019
The US-China trade conflict continued to impact markets after President Trump went back on an earlier decision and imposed additional tariffs in retaliation to China’s plans to hit $64bn of US goods with duties. Global equities fell as a result and earnings expectations for US companies have been downgraded.
On 4 September, the Treasury released an update on proposed reforms to the Retail Price Index. There is now an expectation that RPI will be set to mirror CPIH at some point between 2025 and 2030. This will have a dramatic impact on the return that an investor in long dated index linked gilts might earn. We don’t believe that this undermines the economics of hedging for most schemes, but it is important to factor into hedge design.
The significant falls in gilt yields over the month would have led to a large increase in the liabilities of a typical pension scheme and consequently a worsening in the funding level.
The typical scheme used has an assumed asset allocation of 27% equities, 34% corporate bonds, 11.6% multi-asset, 4.8% property and 25% in liability driven investment (LDI) with the LDI overlay providing a 50% hedge on inflation and interest rates. This example scheme was 80% funded in 2015.
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