Government bond markets tend not to register as volatile; media headlines typically focus on shares falling by whatever huge amounts.

But spare a thought for holders of index-linked!

Last week saw the largest weekly fall this year in the long index-linked gilt. The index-linked ‘68s (Gilt 0.125% March 2068) started the week at a price of 260 and ended it at 227 – a fall in value of well over 10%.

Index-linked gilts offer security in providing returns linked to inflation (as measured by the Retail Price index) but they do not offer any certainty over capital values – as last week proved.

One of the main drivers of the high price of index-linked debt over the past couple of years has been the implicit exposure to longer-dated bonds – i.e. duration. And last week saw valuations take a tumble.

As our inflation expert James Lynch remarked on BondTalk on Thursday, we saw a re-run of June’s speech by Andy Haldane; this time the market took fright at Gertjan Vlieghe’s conversion to a base-rate hawk from his previous dovish position. As one of the nine voting members of the Bank of England’s Monetary Policy Committee, his “conversion” matters. And unlike Haldane, who suggested rates should reverse last year’s post-Brexit emergency cut of 0.25%, Vlieghe thinks rates need to move beyond that.

Money markets are now pricing 80% likelihood of a 25bps rate hike for the November meeting; but the trajectory beyond that is far from certain. Unwinding last year’s questionable base rate cut might make sense, but do not confuse that with an ongoing ratcheting of rates higher. Oddly if that were to be the case, index-linked bonds would likely reverse some of last week’s falls.

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