Ahead of the UK Budget today, fixed income managers are positioning portfolios for a disinflationary outcome, according to findings from Morningstar.
“The fixed income managers we surveyed largely view that the upcoming UK Budget will not be a material event for markets, anticipating a fall in Gilt yields due to weaker growth and potential Bank of England rate cuts,” said Evangelia Gkeka, senior analyst for fixed income strategies at Morningstar. “The Pound is also expected to weaken, though markets have likely priced this in.”
Gilts remain attractive, offering positive real yields above inflation.
“Most managers are currently positioned in favour of long UK interest rate duration, expecting capital gains as yields decline,” said Gkeka.
On the corporate side, financials and defensive sectors like food retailers and healthcare are preferred, noted Gkeka, while managers avoid cyclical sectors like autos and chemicals.
In high yield, managers are focused on companies with resilient cash flows, avoiding high-beta, cyclical and highly leveraged companies.
“The majority of managers believe the focus of the UK Budget should not only be on increasing taxes from already high levels,” said Gkeka. “Bringing spending under control, they argue, is a better long-term solution and adds to long-term policy credibility.”
Although market watchers have been keeping a keen eye on the gilt market.
Things were calm overall until the u-turn on proposing to increase income tax a couple of weeks ago.
“When we think about the market backdrop, it is obviously one of difficult debt dynamics for the UK, although many international peers are in a similar situation,” said Anthony Willis, senior economist at Columbia Threadneedle Investments.
“The UK does appear to be suffering a period of low growth and, more recently, high inflation, and we think back to various economic shocks over the past 15 years or so,” he added.
The UK, noted Willis, is vulnerable to higher debt levels, and inflation picking up with corresponding rate hikes has had a significant impact on debt servicing costs.
“The UK has a potent mix of short-dated and index-linked debt, which means that when inflation picks up and interest rates are raised you get significantly higher debt service costs,” added Willis. “In terms of the government finances, it means that over 7% of their budget is now going on interest payments – this equates to over £100 billion a year.”
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