Gilts short term strategy?

[bluedonkey]

Thank you to 1nvest for those detailed posts. I even understood part!

I'm a happy purchaser of TN24, maturity date 31.1.24. Any thoughts about putting any extra money into TN25 instead, maturity date 31.1.25? Presumably it depends on one's view of likely interest rates available in 31.1.24 when that redeems and releases funds for reinvestment. Buying TN25 now locks in the c.4.9% yield for longer but exposes one to greater price volatility in the meantime. The 3 month yield ranges on yieldgimp imply a fair amount of volatility. As far as I can tell, gilt yields appear to be trending lower.

[mc2fool]

Buying TN25 now locks in the c.4.9% yield for longer but exposes one to greater price volatility in the meantime.

(How much) Do you care? If you intend to hold to maturity and it's money that would otherwise have gone into a fixed term 1 year+ bank/building society a/c ...

[bluedonkey]

Buying TN25 now locks in the c.4.9% yield for longer but exposes one to greater price volatility in the meantime.

(How much) Do you care? If you intend to hold to maturity and it's money that would otherwise have gone into a fixed term 1 year+ bank/building society a/c ...

Yes, but it may turn out that I need the money earlier; or better rates appear around 31.1.24.

[mc2fool]

(How much) Do you care? If you intend to hold to maturity and it's money that would otherwise have gone into a fixed term 1 year+ bank/building society a/c ...

Yes, but it may turn out that I need the money earlier; or better rates appear around 31.1.24.

Or maybe worse rates will appear then. At some point you just have to make a decision and go with something, otherwise that way lies madness if you're forever trying to crystal ball future interest rates!

And that's not just for gilts but also any kind of term accounts. I have a couple of 1 year fixed term savings a/cs that don't mature until next year and were competitive at the time of opening but that I'm now getting better interest rates than from instant access a/cs. Ho hum!

[Aminatidi]

Yes, but it may turn out that I need the money earlier; or better rates appear around 31.1.24.

Or maybe worse rates will appear then. At some point you just have to make a decision and go with something, otherwise that way lies madness if you're forever trying to crystal ball future interest rates!

And that's not just for gilts but also any kind of term accounts. I have a couple of 1 year fixed term savings a/cs that don't mature until next year and were competitive at the time of opening but that I'm now getting better interest rates than from instant access a/cs. Ho hum!

This is pretty much where I got to.

At the very least you know what you're getting when you buy so it's not quite as bad as losing money just the same frustration of seeing savings account rates improve almost daily and knowing someone will offer a better rate as soon as you open one

[monabri]

Or maybe worse rates will appear then. At some point you just have to make a decision and go with something, otherwise that way lies madness if you're forever trying to crystal ball future interest rates!

And that's not just for gilts but also any kind of term accounts. I have a couple of 1 year fixed term savings a/cs that don't mature until next year and were competitive at the time of opening but that I'm now getting better interest rates than from instant access a/cs. Ho hum!

This is pretty much where I got to.

At the very least you know what you're getting when you buy so it's not quite as bad as losing money just the same frustration of seeing savings account rates improve almost daily and knowing someone will offer a better rate as soon as you open one

<<digression>>
Some of the savings accounts are offering 1 year fixed rate bonds of 6% (even the Nationwide offers 5.5%). One could create a short term "ladder" using building society fixed rate bonds ( I have - recently using online fixed rate bonds from the Nationwide and Skipton). The amounts invested in 1,2,3 year bonds could be £17k,£8k, ~£6k - amounts chosen to stay below the current £1k allowance on savings. The bonds are "locked in" so interest vests in the year the bond matures.
<<digression>>

[daveh]

This is pretty much where I got to.

At the very least you know what you're getting when you buy so it's not quite as bad as losing money just the same frustration of seeing savings account rates improve almost daily and knowing someone will offer a better rate as soon as you open one

<<digression>>
Some of the savings accounts are offering 1 year fixed rate bonds of 6% (even the Nationwide offers 5.5%). One could create a short term "ladder" using building society fixed rate bonds ( I have - recently using online fixed rate bonds from the Nationwide and Skipton). The amounts invested in 1,2,3 year bonds could be £17k,£8k, ~£6k - amounts chosen to stay below the current £1k allowance on savings. The bonds are "locked in" so interest vests in the year the bond matures.
<<digression>>

You could but you'd start losing money to tax at 19%, 20%, 21%, 41%, 46% etc plus loss the interest allowance as your income moves into the higher tax brackets. I've been buying the low coupon gilts for exactly that reason. I'm building a gilt ladder at the moment. With 5k per year. So far just TN24 and TN25. Next week it will be a gilt maturing in 26, I've not decided whether it will be an IL or an normal gilt yet. Then one in 27 or 28 depending what's available. When they mature the money may buy another gilt a further year out or go into my ISa if I can't use up the allowance. The advantage is that if the money is needed I won't loss much if I have to sell early

Edit to add I'm very close to the 43k higher rate tax point, so need to be very careful as it won't take much extra interest to push me into higher rate tax. I'd have to pay more into my pension via salary sacrifice to bring me back below the 43k higher tax point, and I'd need to tell work in good time so they take the payment this tax year.

[Aminatidi]

So is there any basic "rule of thumb" on what a the market price of a gilt like TN28 might do if there are future rate rises?

Looking at the graphs on LSE it seems it bottomed at around 78 during the Truss episode.

I doubt there's any firm maths but I'm trying to work out if the odd 25 or 50bps adjustment to rates will do anything significant to it.

[kempiejon]

So is there any basic "rule of thumb" on what a the market price of a gilt like TN28 might do if there are future rate rises?

TN28 market price will change if there are future rate changes - probably. You can buy TN28 for around £82.40 and on 31/01/2028 get back £100 which is something like 4.5% if held to maturity. Twixt now and then there's the market price.

Isn't the attraction of shorter dated gilts, like TN24 and TN25 that you know how much capital you will get back on the given maturity dates.

[monabri]

So is there any basic "rule of thumb" on what a the market price of a gilt like TN28 might do if there are future rate rises?

TN28 market price will change if there are future rate changes - probably. You can buy TN28 for around £82.40 and on 31/01/2028 get back £100 which is something like 4.5% if held to maturity. Twixt now and then there's the market price.

Isn't the attraction of shorter dated gilts, like TN24 and TN25 that you know how much capital you will get back on the given maturity dates.

Specific to TN28. A plot of total return (more or less shareprice as the coupon is negligible). Now, in your mind, superimpose bank interest rates over the period.


source https://www.hl.co.uk/funds/fund-discoun ... ion/charts

[mc2fool]

So is there any basic "rule of thumb" on what a the market price of a gilt like TN28 might do if there are future rate rises?

Looking at the graphs on LSE it seems it bottomed at around 78 during the Truss episode.

I doubt there's any firm maths but I'm trying to work out if the odd 25 or 50bps adjustment to rates will do anything significant to it.

Yes...

Duration (different to and not to be confused with time to maturity): Duration is a measure of the sensitivity of the price of a bond or other debt instrument to a change in interest rates. In general, the higher the duration, the more a bond’s price will drop as interest rates rise (and the greater the interest rate risk). For example, if rates were to rise 1%, a bond or bond fund with a five-year average duration would likely lose approximately 5% of its value.

Modified Duration: The modified duration of a bond helps investors understand how much a bond’s price will rise or fall if the YTM rises or falls by 1%. This is an important number if an investor is worried that interest rates will change in the short term.

And to calculate that you need...

Macaulay Duration: Macaulay duration finds the present value of a bond’s future coupon payments and maturity value. ... Because Macaulay duration is a partial function of the time to maturity, the greater the duration, the greater the interest rate risk or reward for bond prices.

See https://www.investopedia.com/terms/d/duration.asp, which comes complete with "firm maths". (Well, you did ask! )

But fear not, Tradeweb* lists Modified Duration for all gilts in issue. For TN28 it's currently 4.321157.

* Registration required but it's free and they don't spam you.

[dealtn]

TN28 market price will change if there are future rate changes - probably.

Gilt prices change not because of changes in (policy) rates. They change as the expected changes in that path of interest rates gets reassessed. That is a subtle but huge difference.

It is perfectly normal that gilt prices go up when (policy) interest rates also go up, and vice versa fall when that interest rate falls. It is usual that gilt prices go up, or down, most days, when policy rate doesn't change.

Even for a gilt with a maturity in 2028 that is an instrument that will be pricing off the potential of the next 50 or so policy rate decisions. That's quite a bit of potential price volatility even for something with a known redemption amount not that far off. For an index linked gilt that applies to 50+ inflation releases as well as interest rate decisions, in determining what the redemption will be.

[GoSeigen]

So is there any basic "rule of thumb" on what a the market price of a gilt like TN28 might do if there are future rate rises?

TN28 market price will change if there are future rate changes - probably.

Gilt prices change not because of changes in (policy) rates. They change as the expected changes in that path of interest rates gets reassessed. That is a subtle but huge difference.

It is perfectly normal that gilt prices go up when (policy) interest rates also go up, and vice versa fall when that interest rate falls. It is usual that gilt prices go up, or down, most days, when policy rate doesn't change.

Even for a gilt with a maturity in 2028 that is an instrument that will be pricing off the potential of the next 50 or so policy rate decisions. That's quite a bit of potential price volatility even for something with a known redemption amount not that far off. For an index linked gilt that applies to 50+ inflation releases as well as interest rate decisions, in determining what the redemption will be.

To the original question: yes, there is a basic rule of thumb. But there are two parts as alluded to by mc2fool and dealtn:

-as a rule of thumb, the shorter the maturity of gilt, the more directly its yield tracks the monetary interest rate. TN24 as a shortish 4-year-gilt will see a partial transmission of policy rates. Gilt prices can even move opposite to interest rates, especially at the long end.

-as a rule of thumb, if a bond's yield (i.e. NOT the interest rate) moves by x then its price moves by duration multiplied by x. Which measure of duration you use doesn't matter too much for arriving at an estimate [mostly they will be close to each other].



GS

[GoSeigen]

TN24 as a shortish 4-year-gilt

DAK why I am still living in 2020???

Should say TN28 of course.


GS

[mc2fool]

It is perfectly normal that gilt prices yields go up when (policy) interest rates also go up, and vice versa fall when that interest rate falls.

[GoSeigen]

It is perfectly normal that gilt prices yields go up when (policy) interest rates also go up, and vice versa fall when that interest rate falls.

No, he dealtn meant exactly what he wrote, and I agree.

GS

[mc2fool]

No, he dealtn meant exactly what he wrote, and I agree.

GS

Uh? Explain. It's certainly not what we've seen over the last year or two and definitely isn't the textbook relationship. I'm sure you're familiar with the likes of:

"Bonds have an inverse relationship to interest rates. When the cost of borrowing money rises (when interest rates rise), bond prices usually fall, and vice-versa." https://www.investopedia.com/ask/answers/why-interest-rates-have-inverse-relationship-bond-prices/

So what are the two of you trying to say?

[GoSeigen]

Uh? Explain. It's certainly not what we've seen over the last year or two and definitely isn't the textbook relationship. I'm sure you're familiar with the likes of:

TN28 market price will change if there are future rate changes - probably.

Gilt prices change not because of changes in (policy) rates. They change as the expected changes in that path of interest rates gets reassessed. That is a subtle but huge difference.

It is perfectly normal that gilt prices go up when (policy) interest rates also go up, and vice versa fall when that interest rate falls. It is usual that gilt prices go up, or down, most days, when policy rate doesn't change.

Even for a gilt with a maturity in 2028 that is an instrument that will be pricing off the potential of the next 50 or so policy rate decisions. That's quite a bit of potential price volatility even for something with a known redemption amount not that far off. For an index linked gilt that applies to 50+ inflation releases as well as interest rate decisions, in determining what the redemption will be.

dealtn explained it in reasonable detail above. The yield of a gilt is based not on the [real] value of the next coupon but on the value of the entire stream of coupons (discounted). For longer gilts, that's a lot of coupons.

If the market determines that increases in the monetary interest rate will result in a lower inflation rate for some years and they still require the same real yield, then the nominal yield of long-term gilts will fall, not rise.

Similarly, if the market determines that low real monetary rates combined with an increased money supply and a central bank holding a large proportion of government bonds will result in potential difficulty for the government servicing its debt and/or the central bank controlling future inflation then long-term yields may rise notwithstanding any short-term fall in monetary rates.

You will note that the yield curve is currently inverted. This is not the normal state of affairs and is likely to reverse at some point. That implies short yields falling much faster than long yields, or even long rates rising while short yields fall. This is why I repeatedly warn about buying longer-dated gilts at this time. There is ample scope for disappointment notwithstanding the much lower prices of gilts now relative to a couple of years back.


GS

[GoSeigen]

No, he dealtn meant exactly what he wrote, and I agree.

GS

Uh? Explain. It's certainly not what we've seen over the last year or two and definitely isn't the textbook relationship. I'm sure you're familiar with the likes of:

"Bonds have an inverse relationship to interest rates. When the cost of borrowing money rises (when interest rates rise), bond prices usually fall, and vice-versa." https://www.investopedia.com/ask/answers/why-interest-rates-have-inverse-relationship-bond-prices/

So what are the two of you trying to say?

I'll just add IMO investopedia.com is not a reliable source of teaching about investment. Much of their stuff is sloppily written or just plain wrong. Even wikipedia is better.

The article you linked to is a complete mess, the authors repeatedly refer to interest rates but IMO what they actually mean is yields. Being US-centric makes it worse, because in the UK "interest rates" almost always refers to monetary rates in the financial literature (though with a wider meaning to laymen) while in the US what we call the base rate (from which other "interest rates" are priced) is called the Fed funds rate.

My point is this. Bond prices always move in inverse relationship to their yield: that is a mathematical certainty. They DO NOT necessarily move inverse to (monetary) interest rates because neither do bond yields track interest rates exactly. Bond yields are set by the market (via price) based on its assessment of the effect of those rates; but there is NO direct mathematical relationship with interest rates.


Hopefully this clears it up...

GS

[mc2fool]

Uh? Explain. It's certainly not what we've seen over the last year or two and definitely isn't the textbook relationship. I'm sure you're familiar with the likes of:

Gilt prices change not because of changes in (policy) rates. They change as the expected changes in that path of interest rates gets reassessed. That is a subtle but huge difference.

It is perfectly normal that gilt prices go up when (policy) interest rates also go up, and vice versa fall when that interest rate falls. It is usual that gilt prices go up, or down, most days, when policy rate doesn't change.

Even for a gilt with a maturity in 2028 that is an instrument that will be pricing off the potential of the next 50 or so policy rate decisions. That's quite a bit of potential price volatility even for something with a known redemption amount not that far off. For an index linked gilt that applies to 50+ inflation releases as well as interest rate decisions, in determining what the redemption will be.

dealtn explained it in reasonable detail above. The yield of a gilt is based not on the [real] value of the next coupon but on the value of the entire stream of coupons (discounted). For longer gilts, that's a lot of coupons.

If the market determines that increases in the monetary interest rate will result in a lower inflation rate for some years and they still require the same real yield, then the nominal yield of long-term gilts will fall, not rise.

Similarly, if the market determines that low real monetary rates combined with an increased money supply and a central bank holding a large proportion of government bonds will result in potential difficulty for the government servicing its debt and/or the central bank controlling future inflation then long-term yields may rise notwithstanding any short-term fall in monetary rates.

You will note that the yield curve is currently inverted. This is not the normal state of affairs and is likely to reverse at some point. That implies short yields falling much faster than long yields, or even long rates rising while short yields fall. This is why I repeatedly warn about buying longer-dated gilts at this time. There is ample scope for disappointment notwithstanding the much lower prices of gilts now relative to a couple of years back.


GS

Hum, well I do get that prices are set by market sentiment driven by the market's view of future real return expectations (and is why I'm a hold-to-maturity "saver" type ), but I still don't think that gilt prices going up when interest rates rise is a fair generalisation.

For most of the last two or three decades, when the yield curve has not been inverted, a drop in short term interest rates has resulted in a drop in long(er) term yields, as the view has been that the lower rates were here to stay. Indeed, the drops in interest rates after the 2008 debacle, and resultant drop in long term yields, was due to fear of deflation.

So, yeah, sure, if the market thinks that increases in the interest rate will result in lower inflation, but they might not, so I don't think it's a good generalisation and, while certainly not absolute, I think the more textbook view is probably a better one, at least as far as generalisations go.

P.S. Edit...

My point is this. Bond prices always move in inverse relationship to their yield: that is a mathematical certainty. They DO NOT necessarily move inverse to (monetary) interest rates because neither do bond yields track interest rates exactly. Bond yields are set by the market (via price) based on its assessment of the effect of those rates; but there is NO direct mathematical relationship with interest rates.

Yep, there we do agree. They do not necessarily move either way to changes in monetary interest rates.