Is it time to invest in the Government?

Whilst it is perhaps too soon to think about bargain hunting in the equity markets – traders warn against trying to “catch a falling knife” – it may make sense to think about Gilts in these volatile markets. Government bonds can be a source of liquidity for banks and traders under pressure and markets in shock. This can be reflected in short-term moves, but a cool appraisal of fundamentals could see investors consider government debt a safe haven.

A mandate around inflation

Whilst the Monetary Policy Committee’s mandate is primarily around inflation, it has demonstrated – in the wake of the Global Financial Crisis as well as during the pandemic – that it is willing to keep rates lower and for longer when it believes that is necessary for the overall health of the economy. Indeed, arguably it has, in the past, overshot on both metrics. Trying to read the runes is never easy, but some of the MPC’s members have already made their views clear. 

In late March, Swati Dhingra (albeit the lone voice in favour of a cut at the last meeting) said that she believed that tariffs would bring global price levels down as trade volumes drop. Megan Greene, another member, has also gone on record suggesting tariffs could be disinflationary. The fall in the oil price (Brent is down from $75 to $63.25 since early last week) will give some relief to the CPI, though the feed-through from the NI increases will presumably cause an upward blip. 

What do the forecasters say?

Forecasters remain divided about the trajectory of BoE rate cuts, with the swaps market pricing 90 basis points of cuts through the remainder of 2025 at one point this morning (back however to around 50bps at the time of writing). 

Some forecasters (ING for example) have the bank rate falling as far as 3.25% next year. Sterling Treasury bill rates have started to fall already in recent weeks. But Gilt prices further out have not responded: fear about government funding requirements still balances the expectations of lower short rates (the Bank of England has little control of rates beyond six months, unless it re-embarks on a Quantitative Easing programme, and at present it is still in the process of unwinding it). 

Market expectations for inflation in the medium- to long-term also remain elevated (e.g. 3.25% for the 10-year), which would need to soften to some extent to allow for a sustained rally in Gilts. Ten year Gilts currently yield 4.62%- a little above the level as at the start of March, though they have been as high as 4.8% in the intervening period. At longer maturities (20-30 years) yields well above 5% are still available. If we see the bank rate at 3.25% and still falling next year, it is hard to imagine that gilts yields will not have fallen and prices risen, perhaps quite materially. So, this may be a sensible place to put cash rather than sit and watch deposit rates fall.  

Trump’s tariffs and Fed fund futures

As for the USA, Fed fund futures are pricing in three to four rate cuts from the Fed by the end of the year (having been as many as a full five earlier today). 

If the President persists with tariffs for even three months, that seems likely to cause profound damage to the economy. This could perhaps be enough to cause the Fed to entertain emergency rate cuts, potentially of greater size up to a full percent at a time, which helps explain the pricing that we see in the futures market. 

A CEPR paper last year noted: “Tariff shocks may present policymakers with a particularly difficult choice between moderating inflation and the output gap […] even while tariffs are likely to be inflationary, it might be optimal for policy to focus more on the inefficient fall in output [in other words, to cut rates]. These factors include the likelihood [now certainty!] that US tariffs could be reciprocated in a tariff war, [and] the fact that current tariff threats seem centred more on final consumption goods rather than intermediate inputs in domestic production…”, which  seems like a reasonable appraisal. 

In the deep US corporate bond market where credit spreads had looked surprisingly low earlier in the year, there have been signs of greater risk aversion. A weakening US economy would certainly increase risk and push spreads up, countering any positive effect on corporate bond prices from falling Treasury yields.