January 2010
Market review
The UK gilt market underperformed and yields rose over the quarter led by intermediate dated
securities. The move came mostly in December driven by the continued strong performance
from risk assets and a significant rise in US treasury yields. Good demand for longer dated
securities coupled with little supply supported this area of the curve.
Sterling credit performed well as spreads narrowed on the back of improved economic data and
continued strong demand for corporate bonds. As a result, spreads tightened 0.26% to end the
quarter at 1.69% over gilts.
The sterling Libor curve has seen yields rise during the quarter, which has taken the 1 year rate
higher by 15bps to 1.25% - from 6 months out yields are higher circa 10-15bps. The curve
overall is steeper by 13bps. The very short end continues to be anchored by official rates.
Market outlook
The continued weakness in the economy suggests there is a lot of spare capacity and that
dis-inflationary pressures are likely to dominate. The sustainability of any recovery remains
uncertain given the substantial headwinds that face the UK economy. Against this background
we expect the MPC to keep the base rate at a low level for some time. The market is currently
of the view that the asset purchase scheme will not be extended any further. However, we
believe that the MPC will continue to monitor the situation and will increase it if necessary.
The gilt market is likely to be volatile in the short term and expect the yield curve to flatten
between 10 and 30 year maturities, although there may be supply issues to face.
In the credit markets, we remain broadly positive in the short term given the strong technical
backdrop and companies’ ongoing focus on rebuilding financial strength. However, we are
mindful of the many downside risks which remain, including central banks removing stimulus
measures or raising rates too quickly and concerns over weaker sovereigns’ credit quality.
With base rates unlikely to rise until Q4 2010, we are seeing value in the money market curve
in the 6-9 month area. We are mindful though that the market may well move ahead of any
official base rate increase and as such are positioned to take advantage of higher yields.
Portfolio Activity