What are gilt yields? Investing Explained

In this series, we break through the jargon and explain a popular investment term or theme. Here it is gilded returns.

What are they?

Gilts are British government bonds issued to fund government bonds.

They are called gilding because the original certificates had gilded edges.

The first gilt was published in 1694 by William of Orange to finance the war against France. Today, the Debt Management Office (DMO) manages the issuance of gold on behalf of the government.

They pay a fixed interest rate – called a coupon – and most have a fixed maturity date. Indexed gilts provide inflation resilience of both capital and coupon.

Gilts are traded in the markets, meaning their prices fluctuate.

The return on a gilt is the annual coupon as a percentage of the price.

For example, if the coupon is £10 and the price is £200, the return is 5 percent. When prices fall, revenues rise and vice versa.

Why are they in the news?

Sterling’s decline after the mini-budget raised fears that interest rates could rise faster and further than expected.

As a result, gold prices plummeted and yields soared. The typical return on gold-plated products rose to 4 percent, the highest level since the global financial crisis in 2008. At the beginning of the year, the yield was about 1.3 percent.

As a result, UK final pay pension funds, which are major investors in gilts, had to meet the demand for complex leveraged liability driven investments (LDIs).

The sale of gilts by these funds threatened to create a “doom loop” by lowering prices, resulting in even more money calls.

What does it mean to me?

The Bank of England intervened in the gold market last week to avert the crisis. Chancellor Kwasi Kwarteng’s turnaround on the abolition of the 45 percent income also improved sentiment.

Gilts (unlike leveraged LDIs) are still considered a safe investment.

The surge in yields sparked a wave of purchases by retail investors seeking an income and a safe home for their money. Bonds maturing in 2025 were among the most popular.

But in these feverish times there is the possibility of further disruptions.

And the impact of government bond yields has broader implications for mortgages.

Sounds ominous

Indeed. Bond yields affect money market swap rates that determine the price of fixed-rate mortgages – chosen by millions of home buyers.

Swap rates are the rates that mortgage lenders pay to financial institutions to acquire fixed-rate financing over a specified period of time. Due to the surge in bond yields, lenders have withdrawn their offers and will replace them with more expensive alternatives. This has led to many jokes about home buyers paying the ‘Kwarteng premium’.

A year ago, the average two-year fixed-rate deal was 2.2 percent, but it’s starting to rise. According to analysis group Moneyfacts, that is now 6.11 percent.

In the summer of 2021, the typical five-year yield was 2.75 percent; it is now 6.02 percent.