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Bonds

December 2008

Government bond prices rose sharply in November. This was in spite of fears that investors will struggle to digest the vast increase in the supply of government debt that will be required to return the financial sector to health.

There was a succession of interest rate cuts in the UK, the eurozone, Switzerland and Australia. The most aggressive rate cut was in the UK, where the Bank of England slashed borrowing costs by one-and-half percentage points to 3% - the biggest cut since 1992 and far more than the market had expected. The European Central Bank cut rates by just half a percentage point, but ECB President Jean-Claude Trichet hinted at further cuts to come.

In the US, as market observers focused their anxieties on the automobile and finance industries, yields on US government bonds fell to historic lows. The trend was accelerated by the US Federal Reserve’s decision to buy $600 billion of mortgage bonds issued or guaranteed by government agencies. This pushed mortgage rates sharply lower, and the prospect of a wave of mortgage refinancing encouraged investors to hedge that risk by buying ten-year Treasury debt. At one stage the yield on ten-year Treasuries fell to 2.82%, the lowest point in five decades. Over the month, yields on ten-year US Treasuries fell from 3.98% to 2.97%.

The pattern was replicated elsewhere in the developed world. UK gilt yields fell from 4.53% to 3.77%, and German ten-year Bunds fell from 3.91% to 3.25%. Credit markets continued to flounder throughout November, unnerved by equity market volatility and the steady stream of poor economic data from around the globe. Liquidity remains poor, and new issuance has all but disappeared. The iTrax Crossover index of mainly high yielding corporate bonds – a commonly-used measure of investor risk aversion – hit a record high, and US junk bond yields rose above 20%.

 

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Scottish Widows Investment Partnership Limited (SWIP) is registered in England and Wales, Company No. 794936. Registered Office is at 10 Fleet Place, London EC4M 7RH. Tel: 0131 655 8500.
SWIP is authorised and regulated by the Financial Services Authority and is entered on their register under number 193707 (www.fsa.gov.uk).