In this series, we bust the jargon and explain a popular investing term or theme. Here it’s gilt yields.
What are they?
Gilts are UK government IOUs, issued to fund state borrowing.
They are called gilts because the original certificates had gilded edges.
The first gilt was issued in 1694 by William of Orange to finance war against France. Nowadays, the Debt Management Office (DMO) manages gilt issuance on behalf of the Government.
Government IOU: Gilts pay a fixed rate of interest – called a coupon – and most have a fixed maturity date
They pay a fixed rate of interest – called a coupon – and most have a fixed maturity date. Index-linked gilts offer inflation-proofing of both the capital and the coupon.
Gilts are traded on the markets which means that their prices fluctuate.
The yield on a gilt is the annual coupon as a percentage of the price.
For example, if the coupon is £10 and the price is £200, the yield is 5 per cent. When prices drop, yields rise and vice versa.
Why are they in the news?
The fall in sterling following the mini-Budget provoked fears interest rates could rise faster and further than had been expected.
As a result, gilt prices tumbled and yields rose very sharply. The typical gilt yield increased to 4 per cent, its highest level since the global financial crisis in 2008. At the beginning of the year, the yield was about 1.3 per cent.
This resulted in UK final salary pension funds, which are big investors in gilts, having to meet cash calls on complex leveraged liability Driven Investments (LDIs).
Sales of gilts by these funds threatened to set off a ‘doom loop’ by sending prices lower, resulting in further cash calls.
What does it mean for me?
The Bank of England intervened last week in the gilt market to stave off the crisis. Chancellor Kwasi Kwarteng’s U-turn on the abolition of the 45 per cent rate of income also improved sentiment.
Gilts (as opposed to leveraged LDIs) are still regarded as a safe investment.
The surge in yields led to a wave of buying by private investors, looking for an income and a safe home for their money. Bonds maturing in 2025 have been among the most popular.
But in these febrile times, there is the possibility of further upsets.
And the fall-out from gilt yields has had wider implications for mortgages.
Sounds ominous
Indeed. Bond yields affect money market swap rates which determine the price of fixed rate mortgages – chosen by millions of home-buyers.
Swap rates are the rates that mortgage lenders pay to financial institutions to acquire fixed rate funding for a period of time. As a result of the surge in bond yields, lenders have withdrawn their offers and will be replacing them with more expensive alternatives. This has provoked many witticisms about home-buyers paying the ‘Kwarteng premium’.
A year ago, the average two-year fixed rate deal was 2.2 per cent but beginning to move upwards. It is now 6.11 per cent according to analytics group Moneyfacts.
In the summer of 2021, the typical five-year rate was 2.75 per cent; it is now 6.02 per cent.
