(Bloomberg) — The selloff in UK markets at the start of January has created value in government bonds, especially with investors underpricing the interest-rate cuts needed to support the economy, according to Fidelity International.
Most Read from Bloomberg
The dramatic surge in UK yields was a case of the market “just blindly following” a selloff in US debt, said Mike Riddell, a portfolio manager at the firm which oversees $926 billion in client assets. Riddell said he bought two-year swaps earlier this month to bet on a lower rate, while adding to a long 10-year gilt futures position against Treasuries.
Ten-year gilt yields soared to 4.92% on Jan. 9, the highest since 2008, as investors showed their concerns over the UK’s high debt levels and the stubborn inflation accompanying a faltering economy. Rates on 30-year debt touched levels last seen in 1998.
“I wanted to get bullish of the front end of the curve because that’s naturally more exposed to Bank of England rates and the policy path,” Riddell said in an interview. Market pricing as the year began for only two cuts by the BOE “just looked wrong,” he added.
The BOE is likely to make three or four cuts this year, said Riddell, who manages Fidelity’s Strategic Bond Fund.
Given how weak the UK economy is relative to the US, market expectations in early January that rates on both sides of the Atlantic would drop by around 50 basis points this year were mispriced, he said. Traders have since increased wagers on BOE cuts and now favor three reductions by year end, compared to two from the Federal Reserve.
UK 10-year bonds were steady in early trading Monday, with the yield at 4.66%.
By holding a moderately long position in UK bonds, Riddell is betting that the latest concerns about the UK fiscal position are unlikely to trigger a wave of capital outflows from the country.
To hedge his position on gilts, Riddell has also opened a short position in the pound, which he believes has further room to fall — even if yields rise again. While higher rates typically boost the attractiveness of a currency, the pound fell earlier this year year, despite the spike in gilt yields, due to broad pessimism toward UK assets.
Pound, Gilts Face More Losses in Headache for Reeves: MLIV Pulse
