This article can be read by selected Monevator members. Please see our membership plans and consider joining! Already a member? Sign in here.
Opportunities in index-linked gilts
≡ Menu
The Latest Articles
Essential Reading
Better Investing
Property Posts
Get Money Motivated
Monevator is a place for my thoughts on money and investing. Read our disclaimer. Subscribe to get all our free posts via email. Follow us on Twitter, Facebook, or via RSS. You can also send us a message.
Copyright © 2007-2024 Monevator. All rights reserved.
Disclaimer: All content is for informational purposes only. I make no representations as to the accuracy, completeness, suitability or validity of any information on this site and will not be liable for any errors or omissions or any damages arising from its display or use. Full disclaimer and privacy policy. This site uses cookies and features affiliate links.
Comments on this entry are closed.
Thanks for excellent research @TI. For longest term ILGs there’s non-trivial risk HMG rewrites rules again (“RPI inflation has consistently been about 1% higher than CPI”). Buy shares & there’s risk company dilutes with new issuance. Buy corporate bonds & issuer can strong arm creditors with new terms or leverage up balance sheet to point there’s no comfort in owning CBs. But, in each case, the issuer has to operate within a legal system that they don’t control. That’s not true when you buy sovereign debt. Using primary leg’s HMG can undermine the investing case for ILGs with more shifting of goal posts on the index linking mechanism. BTW I’m not one of the tin foil hat brigade who thinks (to parody) that the Government is ‘coming to take away our gold’ or similar. It’s just WTSHTF governments have been known to manipulate the technicalities (like RPI v CPI linking) to ease things. Less an issue over short term, but over decades negative surprises on this are more likely.
@TLI — Cheers and it’s a risk, I suppose. The Mini Budget showed there are limits to messing around though, and it’s not like the argument for switching to CPI is entirely bogus, although it certainly is debatable and it seems retrospective. (By the way, for the benefit of other readers WTSHTF = When The Shit Hits The Fan.)
@all — Please don’t anchor to Mogul posts being nearly 6,000 words long, it’s not sustainable. 🙂 I meant this one to be at least 20% shorter than Ackman, but it’s 20% bigger. Next month for sure! 😉
Bit surprised this is a mogul article. Where are my stock tips?
Seriously though. In terms of whether to own linkers, it really depends on the objective. If it’s a retirement income, you need to hedge the longevity risk. Annuities are more appropriate. You can use a combination of linkers and equities, but you still need to assume a transition from one to the other and the proportion of each. At 60 say, what linker ladder would you buy? Say 20 years to take you to 80 and just assume equities are much higher by then? Or 35 years to be much safer but then find you have very little capital left for the equity component.
I think the real value of linkers is for bridging known periods. Say until you get your DB pension or state pension or perhaps until you can buy an annuity (typically 55 is the earliest). In that sense it has two clear ways it can be used. First, you use it to provide an inflation protected cashflow to live on each year over that fixed period.
The second is if you feel you might want to annuitize some part of your capital but you are too young to annuitize now. You don’t need the cashflow but need to hedge the risk that annuity rates fall.
Annuity rates are primarily function of 15y+ gilt yields. For a 50-year-old, looking to annuitize at 55, they are exposed to 15-year+ linker yields, 5-years forward. The hedge for that is shorting 5-year linkers and buying 20-year linkers. Now the short is not easy, so really you just buy 20-year linkers. It’s only approximate but it’s not a bad hedge.
If you look at the yield moves since the lows of ’21, you can see why this is an ok approximation.
5y +470bp
10y +400bp
20y +375bp
45y +330bp
So 10y-20y spread is about 25bp flatter and 20y-45y spread 45bp flatter. So 10y/20y/45y butterfly (short 10y and 45y and long 20y) has moved 20bp higher. In a 375bp selloff, 20y has moved about 5% more than 10y or 45y in curve terms. Broadly speaking, if you ignore the front few years (impacted more due to high spot inflation), the curve has been quite stable.
This is also why INXG is a good proxy for a portfolio of long-dated linkers. INXG has a duration of16-17 so acts like a 20-year. I can replace all the bonds from 10y+ with INXG. I will need to rebalance over time but as an initial proxy hedge it works well.
@ZXSpectrum48k — Hah, don’t worry I’m limbering up for one of my beloved tech stocks next month I think, any mad rallies notwithstanding.
Thanks for sharing all the interesting extra info.
Re: Approximations, it seems calculation shortcuts (here and with conventional gilts) are currently particularly doable because coupons are generally quite low, so assumptions made don’t change the long run reinvestment outcomes much. Presumably if rates are back to ‘normal’ then coupons will rise over time as new gilts are issued and make further out returns more uncertain (due to reinvestment risk)?
(Not that this matters right now, or that we couldn’t be back in a 2% Bank Rate world in a couple of years…)
Great article – I’m now a Mogul member thanks to this!
I’m targeting FIRE in 7-10 years, so have been considering a linker ladder since yields turned positive. This would form part of my pre-SIPP pot which would be designed to last from, say 45 to age 60.
However, with real yields at sub 1%, I’m struggling with what to sell to take advantage of this. It doesn’t yet feel like I should be reducing equity exposure to buy linkers (this year’s market is case in point). And I’m 2023, all of my new funds have gone into what one might call linker proxies – namely infrastructure trusts which have derated massively and could offer much better real returns given their inflation linkage, implied discount rates of 8-12% and divi yields of 5-7%.
My gut is that I should shift to buying linkers once I’ve reached my target allocation for equities and infra, since the rest of my portfolio will have longer to work, but perhaps the window for linkers will have closed by then…Interesting times as lots of choices to now consider for investors!
@TI. Clearly low coupons make all of this easier. Real duration is basically maturity, sensitivity to assumptions cashflow reinvestment is less etc. Though even 0.125% reinvested for up to 50 years can add up …
The DMO is issuing ILGs with higher coupons. The 2045 ILG, issued in April, had a 0.625% coupon. On conventional Gilts, we are now seeing sizeable coupons. Nonetheless, we are going to have to see much higher real yields for those coupons to really ramp up. If we get 4% real yields, then god knows where inflation is. UK equities will be on the floor and those income investment trusts will be trading with a massive discount to NAV. Not sure being off by 1 year on your duration calc will be the biggest priority.
Moreover, I just think the whole “build a 30-year linker ladder and forget about it” is just unrealistic. It’s a strategy that won’t survive contact with the enemy. You are going to rebalance your portfolio, so you can correct any approximations during that process.
@LondonYank — Thanks so much for signing up! It is a difficult decision indeed, because the macro picture still seems to be in flux, or at least I for one am being humble about it given how far rates moved so fast and how inflation has persisted. Who’s to say real yields on linkers won’t be 2% in a couple of years? It seems unlikely but not wildly so after the past 18 months. For that reason, I do think linker ladders are currently best suited to those who either (a) have specific capital goals to meet and the money to match them, where they just want inflation protection or (b) same but generalized really to overall wealth. (i.e. You’ve made your ‘nut’ and you want to protect some portion of it come what may).
For those of us still at all in accumulation it’s probably going to better to add to a longer duration index-linked fund such as INXG for the usual wider diversification benefits, and not get cuter until we know exactly where are money will be going in the future. (E.g. De-accumulation).
But these are just general hunches/thoughts. If I was still accumulating but very wealthy by my lights (i.e. I had some other reason for continuing to earn/save than the need to hit ‘my number’) then why not begin to de-risk a chunk of it? In that scenario one has already ‘won’ the game. So as always lots of personal factors.
@ZXSpectrum48K — I take your point about contact with the enemy. (My own portfolio in my busy periods barely survives contact with the news cycle… 😉 ) but as best I can tell there are people who at least claim to buy and own/rundown government bond ladders. I’m not a professional advisor as you know so I’ve not got clients or similar I can point to, I’m going on Internet forums, articles etc. But you must be right it’s a minority pursuit (as it should be right now). As for bigger real yields, yes, you’re right my own portfolio would be listing like the Titanic if we got to 4% real on linkers anytime soon I presume. But I still need/want to try and understand this asset class more generally, so anything I can to beef up my ‘intuitions’ in this area is helpful. 🙂
@TI: wondering if it’s perhaps a tad early to buy into ILGs just yet. 0.8% p a. real yield of course hugely less unattractive than minus 3.2% p.a., but it’s still quite modest, even in historical terms. If it gets to 2% p.a., bearing in mind the near zero default risk, then – for me – it will be in contention.
For that to occur, we might be in a 7% base rate scenario and, assuming we get back to something like the 2.5% margin of base rate over core inflation which was the average from 1985-2008, that might be a world in which core inflation gets stuck (due to strong pay growth) around 4.5%, down from 7.1% now.
Was researching this already, joined up to check this out, however, I’m mostly passive investor so the rest of the articles may not be of interest. It’s a subject with not much UK documentation. This youtube video is helpful if the link is allowed;
https://www.youtube.com/watch?v=Vh5FmZRjBpo
Note that Google Sheets and Libreoffice yield function is different (and other apps that follow the open source specs) its YIELD(Settlement; Maturity; Rate; Price; Redemption; Frequency [; Basis]) ie with a redemption=100 for this subject. Percentage is a decimal ie 0.01 for 1%.
There may be a small error, but as i was just checking/playing around though it was OK for my purposes.
Forgot; also came across this page of bond info, but no documentation – don’t know if anyone knows of any.
https://www.yieldgimp.com/index-linked-gilt-yields
The yields are different to Tradeweb, which with documentation I’d trust more, but maybe there is a difference in assumptions.
@TRS80 — That’s a very interesting looking spreadsheet at first glance. I’ve not seen it before so will have to have a poke around. If anyone does know who created it or can share details of the calculations, that’d be useful cheers. Tradeweb is the gold-standard as I understand it though (on the basis of its links with the DMO) so differences in yield at the YieldGimp site will as you say be down to either different assumptions or, I guess, an error at the latter.
Thanks for signing up. We have over 100 Moguls now and quite a few of them are, judging by their comments over the years, mostly or entirely ‘passive’ investors. So I guess they’re either supporting the site (for which much thanks!) or else they are intellectually interested in other aspects of investing, even if they stick to the passive path.
(More than a few people have told me over the years that reading about active investing on Monevator, where we’re pretty intellectually honest about the odds, is enough ‘excitement’ for them and helps them stay passive! 🙂 )
iWeb now allow you to buy gilts online – at least for TR24 in my case.
@TRS80 — That’s good news, thanks for sharing. How was the spread / dealing inside it?
Looking at the LSE trades, there are not that many trades per day for this bond – typically around 10, so not a great deal of prices to judge in the morning! The range for trading today so far is clean 98.02-98.13 so a spread of 0.12.
Brilliant article. Thanks.
A quick question if I may…
If I were interested in an IL ladder, where the earliest maturity was 3 years away and the final one 5 years away, would it be sensible to take the average maturity of 4 years and just buy three times the amount of that bond, rather than three smaller amounts of the IL bonds maturing in 3, 4 and 5 years? I think the answer is yes, but I may have misunderstood.
@Gareth — Well as the disclaimers say I can’t give personal financial advice. I would say more generally look at one’s goals with creating this ladder?
Would you be looking to manage interest rate risks (and so intending to reinvest as your linkers mature) or are you targeting cashflow payouts in year 3, 4, and 5? In both these circumstances, it would seem more optimal (at the cost of more faff) to buy the three ‘rungs’ of your ladder rather than just the one gilt.
On the other hand if you’re simply looking to add some portfolio ‘ballast’ and diversification with linkers (or to reduce the duration of existing holdings, say a linker fund) then buying the single gilt would work, though obviously you’ll have to reinvest it when it matures and its risk profile will change over the years and it approaches maturity (as will then that of your portfolio, especially if you own it in size).
If you were talking about linkers maturing in 15, 16, and 17 years then I’d probably just buy the 15-year linker. Or even just INXG. There’s much more interest rate risk with longer durations, but a single holding would in practical terms cover off that portion of the yield curve about as well as three separate linkers. (Again if I wanted cashflows in 15, 16, and 17 years time then the better solution would I think to be to buy three linkers today.)
If I’ve misunderstood the question or someone else can give a better answer, please do chime in! 🙂
@TI Thanks for your reply. I’m in deaccumulation so am targeting the cash flow. I’ll go with the three separate linkers I think.
Many thanks for the detailed article. I’ve been considering ILGs as a safe place to keep funds for paying off my mortgage after my current fixed-rate deal ends in May 2026, so this article couldn’t have come at a better time. The depth of information is much appreciated.
ILGs are particularly appealing since I’ll be holding these funds outside of a GIA, and the post-tax real returns on cash savings are unappealing.
I plan to pull the trigger and place an order with Hargreaves Lansdown next week. However, I would greatly appreciate it if somone could clarify a few basic questions I have regarding the tax treatment and returns. Hopefully, others will also find this useful.
For the sake of giving an example, let’s assume the purchase of £100,000 of the 03.26 0.125% ILG at a £96 clean price, held until maturity, with an RPI of 380 at the point of purchase, and an RPI of 437 at maturity (15% increase).
1. In this example, would the total total return (excluding coupons) be 15% from the RPI uplift plus ~4.16% from the difference between the £96 clean price and the £100 clean price at maturity, resulting in a total of £119,160 principal repayment at maturity?
2. Would the entire £19,160 gain be exempt from CGT, or would CGT be due on the £4,160 portion derived from the clean and dirty price difference?
3. Additionally, will the bondholder receive bi-annual coupon payments equivalent to £100,000 x (0.125% / 2) x RPI change for the period? Are these coupons fully taxed as income?
Many thanks in advance for anyone kind enough to clarify!
1. Yes to a first pass, but check with yield function. The nitty gritty of the calculations is on the DMO website https://dmo.gov.uk/responsibilities/gilt-market/about-gilts/
2. All the gain is CGT tax free
3. Yes, and interest is fully taxed as interest not income, but is small due to the low coupon. As it’s interest you do have your interest allowances.
Thanks for this article – signed up recently to learn more about linkers and possibly add to my portfolio.
@Dan – where did you get the RPI figure of 437 at maturity for that particular gilt? I was just looking at this link and they estimate the RPI figure to be 409.1, if I’ve understood correctly?
https://www.yieldgimp.com/index-linked-gilt-yields
On that note, is there anywhere that I can find estimates of RPI figures going forwards?
Thanks @TRS80 – really helpful and much appreciated.
@Jonny – The RPI figures in the example are purely hypothetical. I made them up to give us some round numbers to work with!
1.241% real yield to maturity now achieved on March 2045 ILGs: https://www.lse.co.uk/news/investors-flock-to-fat-return-on-uk-inflation-linked-debt-4322nc4tkkqogix.html
IMO extent of the oversubscription from investors somewhat surprising in light of the consensus shifting in recent days to embrace the possibility of the base rate reaching 6.5%, which would be expected to temper inflation faster and make index linking less attractive on a relative basis.
Signed up as a mogul to read this article! But also enjoying some of the other members ones. @TRS80 I am also looking at TR24 or even T24I (index linked) vs TN24 for short term holding with a tax efficient return. What was your calculus?
Yieldgimp seems to suggest that with real yields of 3.59% and 5.08% (or 3.1 and 3.57 on Tradeweb) it won’t take a particularly high RPI increase for the index linked to outperform the standard gilt, but maybe I am misunderstanding it…
@Boffinboy – I thought TR24 was good as it was the right duration for the current yield curve inversion with 6 months giving the most yield – see first FT link in search
https://www.google.com/search?q=Latest+bond+rates%2C+interest+rates%2C+Libor+and+interbank+rates
Playing around with DMO predictions for guilt redemptions for up to 3 rpi values
https://www.dmo.gov.uk/data/pdfdatareport?reportCode=D9C
subtracting the price you pay ie the dirty price, and adding the coupons to redemption I concluded TR24I had a slightly inferior payback. The big thing is that the TR24I coupons are much bigger, and so would be taxable and was better held in an ISA etc..
Thought the best use was to hold TR24 in a GIA and use an ISA for other taxable investments.
Where else can you get 2+% yield plus RPI inflation guaranteed from the govt?.
Given Mays RPI is ~11% and TR24 uses 3 month delayed RPI – I think you easily get 5%+ RPI during the life of the bond, so seems alot better than 5.5% on 6 month gilts – not sure why this is the case. Also this covers the risk of even sticker inflation.
As said to the Investor – yieldgimp is interesting but we don’t know the assumptions behind its calcs – tradeweb is better from that PoV – so treat its yield with caution.
@TRS80 @Boffinboy — I just found your missing comment @TRS80 in spam and restored it! Apologies. Unfortunately this does seem to be happening now and then, especially if comments have links. 🙁
We have two layers of spam protection, but for context even after the first layer there are still thousands for me to manually hunt through (without a clue such as an email address) if I were to look daily for non-spam posts that have been incorrectly junked by the system before I’ve seen them.
I think the only solution is that if you write a comment with links and it doesn’t get posted then please flag up via a very quick 10-word comment and I’ll have a look. If I see it in spam I’ll restore it, then delete the flagging up post (which I’ve done here 🙂 ) Cheers!
@TRS80 thanks for the thorough rationale – it was puzzling me a bit, and on the edge of my understanding level – but good to see someone else has the same thinking! I am not sure I initially grokked the info in the calculator link – I was being obtuse and was using the clean price. What’s still confusing me is my broker (II) seems to show me the clean price? Mine would be held outside of my ISA so TR24 makes sense for me.
@boffinboy – these are not mainstream products – expect some rough edges from retail brokers. Although Iweb allow me to purchase online, they in the valuation window compare the dirty price paid with the clean price – therefore erroneously showing a loss….
@TRS80 interesting! Will give it a go and see how it turns out. Need to liquidate something else first.
After reading this article I decided to put 10,000 which had been in an Instant access account at 4% into T28 ending 10 August 2028, I am 75 years old and very lucky to have a sizeable SIPP I dont need to touch, a large equity exposure in my ISA and 250,000 in cash. Because interest rates 0f 4% will lead me into paying Tax on the interest I thought the T28 where the gain would be Tax free would be a good idea. I am currently discussing with Interactive Investor the fact that their contract note is implying that the difference between the clean price and the dirty price is interest when in fact the majority is the Tax free inflation gain, Thanks for this site It is well worth supporting.
@John Wilkinson — Thanks for the kind words and for becoming a Mogul member! Please do feel free to pop back and report on where you end up with Interactive Investor when the dust settles, I’m sure other members would be interested. Cheers!
@John Wilkinson I would definitely be curious what II say. I just made an order over the phone and was told they have to manually edit the contract notes.
@John Wilkinson, @Boffinboy & @TI #29-31: Up and down the country the fund platforms are asking themselves why it is that they’re getting inundated now by investors buying individual linkers, and Monevator will have single handedly caused ii to change its contract note processes! Seriously though, you have to wonder why the platforms don’t seem to be able to deal properly with all aspects of ILG purchase/sale. This really should be a straightforward investment, which should be easy to implement. Obviously, IRL, the opposite seems true.
Hi
They have given me a secure message with the correct breakdown but say their contract note process cannot deal with the split between interest and capital. I politely suggested they update their software
@All Moghuls: Not sure if I’m posting into the void, as it’s been several weeks since the last comment on this thread, but just in case not, any thoughts out there about sticking Treasury 0.125% 2065 Index-Linked Gilt into a GIA. No CGT. Has fallen from over £300 at peak to £70 odd now. Seems as though a price bottoming out has taken place. Tiny coupon means minimal IT, although also looks like the platform fee bandits at HL will try to take their cut – but not for INXG as that’s ETF – where’s the logic in that eh 🙂
@All: have now found the legendary / infamous TG73 linker on LSE and HL. First traded on secondary market on 29th November 2021 at £397.74p and is now at £73.10p to buy. It’s a massive bet on falling UK interest rates. My (manual / scientific calculator) estimate is that it’s gone from a minus 2.7% p.a. to a plus 0.65% p.a. real yield to maturity. If real rates hit the mid 1990s peak of ~4% p a. then I estimate that it would fall to around £14. Conversely, if interest rates fall, and we go back to low growth, low rates and lowish inflation economy then it could do quite well. At a 50 year maturity though, I’m not going to be around to see it paid back at par plus the inflation uplift.
With my thanks to @Dan #18 for Q and @TRS80 #19 for A. I’m a bear of little brain, so the simpler version of otherwise mind warping linker bond math is hugely appreciated. Since #22, I’ve changed my opinion on rates as a result of latest core inflation data. Now see them peaking this week and going lower sooner thereafter.
@All: Can anybody out there explain why a super long dated ILG like the Treasury 0.125% 22/03/2073 would fall 3% after the BoE’s rate hold decision this afternoon?
Naively, I had assumed that a lower bank rate and lower inflation expectations would = both higher ILG and higher conventional Gilt prices.
What am I misunderstanding here?
I haven’t brought any ILG yet, and need to feel that I better understand what is going on with the price response before taking the plunge.
Thank you in advance.
@TLI — I wouldn’t read too much into the immediate reaction to an announcement like this. Very often you’re looking at positioning being unwound/played out, as various very short-term traders either collect their winnings or salve their wounds. (@ZX might baulk at this simplification! 😉 Reposition their risk-parity funds for the new expectations too if you like). Often the immediate reaction is not the lasting reaction.
Beyond that there’s a generally ‘higher for longer’ vibe in market expectations of late. The US economy in particular is doing better than expected and this is expected to continue. Soft landing ahoy. The UK is probably at greater risk of an economic upset that most G7 countries, but ‘probably’ is the key factor. The market knows we face slightly stickier inflation issues. So rates on hold may mean the BOE is going to let inflation take longer to come in via more elevated rates for longer, rather than a shorter sharper shock through taking Bank Rate to 6%, say.
Remember Bank Rate doesn’t set market rates, one could almost argue it tries to react to them. Today’s decision was a close call I think it’s fair to say, but generally the market rates are always moving around and the BOE is just one player (except at the very short end, where Bank Rate is certainly a key driver).
I’d wait a day before drawing any firm conclusions anyway. 🙂
That’s super kind of you to respond and so quickly @TI, and super helpful too.
I’d re-re-read your brilliant article, then read this explanation, and thought it all made sense, albeit in an almost counter intuitive way:
https://www.jmfinn.com/our-thinking/inside-index-linked-gilts
But then I thought about it again some more, and it still didn’t quite all hang together: i.e.:
– 2009-21 inflation down, inflation expectations down, interest rates down, so ILGs way up.
-2022 inflation up, rates up and inflation expectations rising (?), so long dated ILGs down really appallingly badly.
All makes sense so far in terms of internal consistency, albeit perhaps contradicting ever so slightly the above linked JM Finn take.
– But then right now, in late 2023, with UK rates seemingly topping out (I think), inflation starting down (I guess) and (one would probably think therefore) inflation expectations falling off; the long dated ILGs are still getting squashed, albeit not completely battered like 2022.
At just £68 and change for the 2073 ILG maturity, it’s now down nearly 84% from the ATH in (IIRC) 2021, and not far from the £53 it touched for all of what looks on the charts like it was for just minutes during the nadir of the Truss/Kamakwasi fiasco. Surely this thing has to bounce soon? There can’t be any sellers left out there! 🙂
@TLI — Well FWIW (members can decide for themselves! 😉 ) I do think ILGs look relatively attractive here in most scenarios, which is of course why I wrote the article. Again though, I’d caution against just looking at where base rate is topping it. It’s a bit like saying all the umbrellas are finally out in the stands at a racetrack. That doesn’t mean it couldn’t keep raining for a long time, before it eases off and they start to come in. I wouldn’t quite go so far to say Bank Rate is a lagging indicator but…
Good Lord. I’ve just checked up on the price of the Treasury 0.125% 2073 ILG – as I edge millimetre by millimetre towards pulling the trigger on buying some – and see that it’s now down (yet again) to just (checks HL website) £63.15/£64.65. I’m not good at the linker YTM maths, but my ‘back of the envelope’, free calculator phone app comp is coming out at a real YTM of ~1% p.a. for nigh on 50 years – which isn’t bad until you consider that I’ll probably be dead before then.
@TLI — It might be helpful to consider that if you could precisely time the bottom the government bond market – overall probably the deepest and most liquid in the world, after currencies, and no backwater even in just the UK context — then you would be a Master of the Universe and rich enough at your age not to worry about getting the last few pennies off. 😉
Of course I was feeling happier when it looked like I’d fluked the bottom for a couple of months with this post! We’re down a bit now.
But the point with IL gilts as I see it is still an asset allocation story. Here is a chance to add something to a portfolio that will behave differently to other mainstream assets and that now will pay you while it does so. That’s big, but the fact that it didn’t for most of the past decade and now does is huge.
As for where the exact bottom is, who knows! 🙂
p.s. Related context, a striking chart this afternoon from Ben Carlson on the crushing of long-term US Treasuries, which is basically the same story:
https://twitter.com/awealthofcs/status/1707094402672292207
Nte the relatively tiny double-dip at the end there…it’s hard not to believe most of the wood has already been chopped here?
So true @TI. I see long rates eventually much lower because I like to try and take the longest view (as you’ve probably guessed, philosophically I follow ‘Long Termism”).
Sometimes it’s the long term which is the easiest future to approximate. The further back we look, then the more clues we can get in order to try and look the furthest forward.
IMO it was right for central banks to do QE to stop us spiralling into Depression 2.0 in 2009 and 2020. Also think that there was a big and underappreciated secular decline backstory to lower market rates which goes back a very long time, and which may perhaps significantly account for just how far the most recent 1981-2021 rate decline ‘mini’ cycle went.
QE/ZIRP was the icing, but the cake was baked in the oven of that declining rates super cycle. In these regards, back in 2015 Andy Haldane gave support to the view that the world was in the down slope of a 5,000 year pattern of declining rates:
https://www.ft.com/content/5689ebd4-c528-3b78-b7ae-6358e804d462
It’s easy to get anchored to 5% rates and higher inflation now because we’ve just been through it. Nonetheless, it was still unexpected. A few positioned for it in late 2021, not least PSH. But it was generally seen as likely transitory then. Had it not been for each of the delays by the FOMC, ECB and BoE in beginning QT and/or starting to raise rates; a bodged Chinese response to Omicron, and that other supply shock of the Russia-Ukraine war; it probably would have been transitory.
With relentless demographic transition progressing worldwide, and with Chinese growth falling due to this and to both Xi’s mismanagement and to two decades of misallocated overinvestment; then (unless the climate crisis throws us a curve ball) demography really should be destiny, leading to persistent demand shortfalls with ever higher taxes for elder care / pensions and fewer wage earners to pay them. This should, in turn, put strong downward pressure on prices and, ultimately, on interest rates.
Demography and the green transition (which, for the avoidance of doubt, I fully support) will necessitate massive and prolonged borrowing, which will only be affordable with fiscal repression (justified for the greater good), resulting in the long end of the rate curve (where gov’s borrow the most) being pushed right down by Central Bank action; and with the short to intermediate end (where consumers and mortgage holders borrow) being allowed to find their higher equilibrium rates, where they can then be used to control any inflation.
Thus consumers and mortgage holders will bear the burdens of inflation fighting episodes in the long term, while gov’s, which have to fund both current spending and make those long term investments for everyone’s benefit, let themselves off the hook.
This is not original analysis on my part. Klement on Investing covered the same ground here:
https://klementoninvesting.substack.com/p/is-this-the-monetary-policy-of-the
Really interesting article / numbers on how high TIPS yields in the US have transformed the landscape for US retirees:
https://www.morningstar.com/bonds/high-tips-yields-are-retirees-best-friend
Remarkable turnaround in just a couple of years.
If anyone has done similar maths for the UK on today’s linkers and would like to share / point to it, please do. 🙂
Fascinating piece – Thank you for finding it @TI.
What an eye opener that with $435k in TIPS & just $65k in US equities – using historic 7% p.a. real terms total return for US large caps (actually 6.5% p.a., but I’m quibbling) – one could draw down $20k p.a. both guaranteed & inflation protected from TIPS element and, having exhausted that over 30 years, end up with a stock position still worth $490k in real terms.
Almost magical compared to ZIRP world.
IIRC Howard Marks said in the go go years of the 2010s that investors should actually want lower prices and higher yields, not ever higher prices and ever lower yields.
Don’t think that the ILG situation is as promising, at least not yet. Been watching Treasury 0.125% 2051 & 2073 maturities on TradeWeb like a hawk, and we’re still well off the current 2.38% p.a. YTM of long dated TIPS. 2051 briefly got up to 1.6% p.a., but has since slipped back several basis points. 2073 is possibly showing more sensitivity to changes in yields of corresponding duration conventional gilts (30 & 50 year), but has only a rather modest 1.15% YTM.
Evidently Mr Market thinks – rightly or wrongly (time will tell) – that the US economy will power ahead, and needs a higher level of real rates for a given level of growth and employment; whereas the UK economy is seen as fundamentally weak, and more prone to recession for any given level of rates. Who knows?
BTW there’s a Washington Post article yesterday comparing views of Howard Marks on US rates (and his bullishness on corporate bonds & relative bearishness towards equities) with Bill Ackman’s stance:
https://www.washingtonpost.com/business/2023/10/17/marks-or-ackman-who-you-gonna-trust-jonathan-levin/d1449482-6ce4-11ee-b01a-f593caa04363_story.html
Good Chart Storm today from Callum Thomas on the unprecedented drawdown in US Treasuries:
https://www.chartstorm.info/p/off-topic-chartstorm-us-treasuries-372?
And Michael Batnick at The Irrelevant Investor covered the asymmetric risk to reward now offered by long dated US Treasuries yesterday:
https://theirrelevantinvestor.com/2023/10/18/not-quite-a-no-brainer/
Thanks for this article. It has helped me enormously.
As a result, I have set up a bond ladder to provide retirement income through to 2035. 50% index linked and 50% conventional.
I have a question though…
Does anyone have any thoughts on what to do should (some of) these bonds appreciate significantly before maturity. Would it be prudent to sell? And if so, what would be a reasonable investment vehicle for the proceeds? Perhaps a shorter duration bond?
@ Gareth – ZXSpectrum48k responded to my question on this point on another thread:
https://monevator.com/retirement-withdrawal-strategy/comment-page-1/#comment-1722634
@TA. If you buy a ladder of linkers and we reverse the last two years, you are probably going to want to lock that in. There is little value in holding linkers at negative real yields. All you would do is bleed those gains back over the remaining period. It would expose you to risk but you’d need to weigh that against the gains you’ve made.
Re: your question about reasonable vehicle and ZX’s comment about ‘risk’
Shorter duration bond or cash
= some but reasonably low interest rate risk if yields rise again.
= reinvestment risk if yields keep dropping.
= inflation risk if conventional bond
So shorter duration means less price volatility especially if interest rates rise. But, say, you did this after interest rates fell in 2008. You’d have given up a lot of return in short duration until rates finally rose again in 2021.
Can I ask a couple of questions about the experience of buying gilts? Which broker did you buy your linkers through? Did they sell them to you as ‘units’? If so, how much was each unit worth? I’m not asking how much you spent in total. Just the value of each unit.
Thank you!
Thanks TA (#49).
I used AJ Bell to purchase my linkers in a General Investment Account. I could have used Interactive Investor but since my equities in my SIPP are with them, I thought I’d take the opportunity to diversify my investment platforms.
I had to phone the orders through but it was straightforward. I asked for a specific value and one of my contract notes (for SEDOL B3D4VD9 – expiry 22-11-2032) shows I have a number of units, each priced at 1.844 (ex-dividend). Each trade cost £9.95 (same as the online dealing charge).
Hope that helps.
Thanks Gareth. That’s very helpful. Cheers!