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Gilt yield surge could prompt 20% market correction, says Morgan Stanley

Morgan Stanley has warned investors that the likely rise in gilts yields in 2010 could lead to a market correction of as much as 20 per cent.

The investment bank says the 15 per cent rise in 10-year gilt yields at the end of 2009, from 3.6 per cent to 4.1 per cent, was the biggest hike in yields since January 2009 and had only happened twice before that, in February 1999 and February 1994.

Morgan Stanley analyst Graham Secker says: “At current levels such sovereign yields are not problematic for stocks. However, we expect yields to rise further over the course of 2010, reflecting a stronger economic environment, somewhat higher inflation, a large ramp-up in supply and, from time to time, fiscal concerns.”

Even so, Secker stresses that the possible market adjustment will not spell the end of the market’s bull run. Morgan Stanley notes that historically, P/E ratios were down 2 per cent, on average, in the 12 months post any bond yield trough.

Secker says: “We believe the UK will ‘limp out of recession’. Although the recent data news flow for the domestic economy has been a bit better than expected, we would use this as evidence that the economy is coming out of recession, rather than an indication as to the strength of the recovery.”

Charles Stanley director of private client research Jeremy Batstone-Carr agrees that yields are likely to rise, but argues that this will adversely affect the economy.

He says: “Yields rising sharply will raise interest costs to the Government and effectively choke off any anaemic recovery that might be in the pipeline, in part a consequence of even more aggressive fiscal policy and in part by driving yields on other domestic loans higher.

“The domestic housing market, apparently crawling out of the morass of the past couple of years would be extremely vulnerable to such a reversal. While 10-year gilt yields are still low, although this may have as much to do with quantitative easing as anything else.”



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There are 3 comments at the moment, we would love to hear your opinion too.

  1. Could Charles Stanley please re-express his view in plain English and explain why the domestic housing market would be ‘extremely vulnerable to such a reversal’ What is the evidence? Who is to say that the Bank of England base rate, already very detached from real rates won’t remain so, keeping housing affordable and a gentle recovery possible?

  2. Ian, the issue is that liquidity is being drained out of the system. Or in English, if there’s set amount of money sloshing around in the economy, and the Government decides it needs to borrow £200bn p.a. of it, that’s £200bn p.a. less money sloshing around…Less to be invested in stocks. Less to be invested in Corporate Bonds. Less for residential lending…To date, there has been a huge increase in retail Banks in the UK holding Gilts rather than lending the money…this is what is happening and what will continue unless there is a firm slashing of Government borrowing.

    Whilst a low Bank rate is helping some of those with existing mortgages (thanks to political pressure), it does not help the level of lending, the affordability of new mortgages etc – which is what drives the housing market.

    Does that make sense?

  3. The value of equities in the UK are less important part of the equation mow as the total value of the UK stock market shrinks. Most of the FT 100 companies are either not really UK owned or derive ther income from non UK sources., This decouples the UK stock market from the UK economy to a a degree. The real factor is that the curent BBR 0f 0.5% is not a valid indicator within the UK economy any longer. It is after all the rate at which the BoE will lend to major financial institutions. As the banks are largely owned by the Government now and a lending money at far more than 0.5%. the name of the game is to widen bank lending margins to recapitalise the banks. I believe that the disaster of Gordon Brown’s financial collapse is that the level of UK borrowing which will have to come from abroad, will force up rates of interest on new gilt issues and drive down prive of existing gilts and indeed other bonds and thus make new borrowing generally very expensive fo all including the Government and the effect will be to force up the cost of financing the National Debt and hence taxes, unless we have a government very soon which slashes government spending by at least £100 billion for each of the next three years. There is now reason why BBR could not be maintained at 0.5% for years to come , however the ones who would gain will be those on long term or lifetime BBR mortgage trackers, while the lending margins over BBR will increase to allow for the extra cost of borrowing to take acocunt of the higher cost of money to pay for the inevitable inflation which must follow the economic collapse of the UK. BBR is really bocoming an irrelevancy in the great scheme of events. However what probably will happen is that the crazy years of financing by debt instead of equity, willl reverse and the rest of the UK will be bought up by cash rich countries in the far east financing purchase of our remaining quoted assets by equity issues in the sunscriber country and low interest bank loans from countries which are running big current account surpluses. Thus is really an extension of the carry trade which has seen most large and valuable UK assets bought up by foreigners. The key to UK recovery can only stem from the need to export goods and services to the value necessary to pay for imports. Otherwise we will see a continued sale of assets to pay for the cost of our insatiable appetite for imports and an ever increasing cost of interest on new money borrowed on new tems to reflect the inflation which seems likely. Whatever happens though the fact that the Governent is faced with raising about £450 billion of new money from gilts to pay for its crazy spending spree, the cost of that at 5% will be £22 billion on the tax bill just for the interest. If the interest payable to obatin that money is say 7.5% which it might well be then the cost is about £34b p.a. just to pay interest let alone repay the debt. This interest bill is just to pay for the new money borrowed let alone interest payable on the existing national debt of £500b plus.
    Bank Rate is dead, long live the true cost of borrowed money which will be typically new gilt yields on all the new issuance, plus a margin on top for commecial and new mortgage borrowers. Let us assume that gilt yields might reach 7% and an extra 2% on top for risk margins. That might be the price of money in future, if the money bags in contries with huge trading surpluses ( China?) decide that the UK and £sterling will progressively
    devalue the the £ by inflation.

    It seems certain that the UK will try to get itself out of trouble not by slashing Govenment spending as is really demanded, but be a continued sale abroad of all of our assets, our property, our roads, our few remaining utilities and what remaining family silver there is.

    There is only one way to avoid this disaster and that is slashing the National Debt funding requrement by paying our way in the world, consuming less, importing less, and living within our means. What Government will do it. Gordons Brown wont, do the Tories have the courage to dish out the revolting tasting medecine once on power and will the successful entrepeneurs in the UK agree to suffer along with the rest of us to stay around to rebuild the UK over the next 20 years needed to repair the damage done by Gordon Browns spend spend spend agenda financed by the sale of UK PLC to foreigners who will extract a heavy price in perpetuity for lending us money to pay for our unaffordabel life stye. Meanwhile a historic statistic called BBR might remain at 0.5%. ! Is Japan a pointer to the future ? A country with National Debt twice the GDP, however with a competiive industrial economy based on powerful world class companies owned by the Japanese themselves. We have the worst of all worlds, crippling debts and a totally uncompettive economy and the worst balance of payments deficit in the world.

    rst balance of payments

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