The UK gilt curve: is it actually steep today?

Investment

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We keep a close eye on movements in UK yield curves to assess the impact on our clients liability valuations and the implications for LDI portfolios. Over Q1, we saw long-dated yields rise materially, while short-dated yields remained low. This movement has pushed down the value placed on UK pension scheme liabilities, but has squeezed liquidity as LDI portfolios have needed to recapitalise with rising rates.

There has been lots in the financial press over recent months on this ‘steepening’ of the UK yield curve and what this might mean. A question we had was: “Is the UK gilt curve actually steep today and what should we be thinking about for our clients’ hedging portfolios?”.

To help answer this question, we decided to look back at the last 30 years to get some context. In particular, we were keen to think about the potential for short-term movement upwards (further steepening) and downward (through further rate cuts or a slower than anticipated recovery out of the COVID pandemic), and then see if there was anything else we could learn.

In summary, what we took from the analysis was:

The UK gilt curve has steepened, but material steepening from here is possible and this could have consequences on funding and liquidity.
Yields could move in the opposite direction – negative interest rates remain a real possibility for the UK and, if implemented, would likely push long-term yields lower as we have seen in Europe.
The spread of long term yields in the UK was far wider than we had expected and the potential stress from yields is greater than risk modelling typically allows for.

There is clear scope for yields to rise or fall materially from current levels over the short-term. Whilst this may not sound like an epiphany in itself, it’s the potential scale of these changes and the consequences on both funding and liquidity that should be considered. We continue to recommend that all our clients review their hedging strategy and the underlying collateral arrangements on a regular basis.