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Bond of the Week: 1 March 2013

Time to punt on UK Gilts?

    

Investors have been conditioned to think that negative news equals falling share or bond prices. In reality, this is not always true. Just recently, British Airways reported a €1 billion loss and its share price rallied 8%. A more distant example is the fall in US ratings in 2011. Standard & Poor's reckoned that US's ability to sustain its mountain of debt was impaired and knocked the country's triple-A rating to AA+ (see here). Bond bears thought it was the end of the US bond market. How wrong they were! The US 10-year bond yield plunged from 2.8% to 2% in a matter of weeks. Short sellers of US Treasuries were decimated, including the 'Bond King' Bill Gross.

This brings us to the recent string of bad economic news in the UK. For the first time in decades, UK lost its triple A rating. Moody's slashed it to Aa1 (see here). What is more worrying is the spate of the lower-than-expected economic data. The weak manufacturing and consumer spending data is raising fear of a 'triple dip' in the UK, which, in turn, is hammering Sterling. All this is supposedly bad for UK Gilts, right?

Well, not exactly. For one, the Bank of England may print doubly hard to resuscitate the economy.  "Nominal GDP targeting" is now BoE's battle cry in the wake of an ineffective QE. What this means is that as long as the GDP growth is sluggish, the UK central bank has a license to print.

Secondly, in an underperforming UK economy, other assets are going to look equally unattractive. On a relative basis, UK Treasuries could even look 'handsome' in a pond of ugly ducklings. Along this line of reasoning, I think some long positions may be opened in the UK gilt sector. Note that coupon is not the focus here, price is.

Already, the 10-year UK gilt yield has slumped from 2.1% to 1.95%, meaning that the market is now unsure if the UK's growth path will be positive in 2013/4. Instead of inflation, the UK economy may need to deal with deflation.      

So, if I am going to buy into the gilt sector, what maturity will I be looking at? I think the seven-year sector is looking reasonable.  In this area, I flagged the July 2020 Gilt as a potential buy.  The bond has corrected a chunky seven points from its June top and is now trading 2-3 points above the 2012 lows (see below). There is some sideways support along the 120 line. The long-term trend here is still undoubtedly bullish.

      

Moreover, the bond's chart pattern favours a reassertion of this uptrend. Since mid-2007, the bond has been developing a twin low pattern; with each low about one year apart. In technical terms, this pattern is known as the 'double bottom'. The recent rebound from 120 could confirm this positive pattern. 

Specifications:

·         Issuer: UK Government

·         Maturity: 3 July 2020

·         Currency: GBP

·         Rank: Unsecured

·         Ratings: Moody's (Aa1); Fitch (AAA)

·         Coupon: 4.75%

·         ISIN: GB00B058DQ55

View: The landscape for the UK sovereign credit has deteriorated in recent weeks. But this may not necessarily lead to a collapse in gilt prices. Currently, Sterling is bearing the brunt of that negative sentiment, while Gilts are firming. Against this backdrop, I am tempted with a long position in the sector. Admittedly, this is a trading idea rather than the usual medium-term buy. Hence, some stoplosses are in order, preferably around the 115 level. 

Jackson Wong

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