Gilt yields have risen sharply in recent weeks following the outbreak of military action by the US and Israel against Iran. Yields on the 10-year government bond rose from 4.23% at the end of February to around 4.7%, although they have eased off slightly to their current level of 4.58%.
At the start of the month, the US and Israel launched a massive strike on Iran as part of ‘Operation Epic Fury’, killing the Iranian supreme leader, Ayatollah Ali Khamenei.
Iran has retaliated by hitting US military bases and neighbours in the Gulf with missile and drone attacks, as well as targeting ships using the globally significant Strait of Hormuz.
Rathbones head of fixed income Bryn Jones said that while he anticipated a rise in yields, the moves in the gilt market “have been aggressive”.
Markets went from suggesting two rate cuts this year by the Bank of England to one rate hike, which he described as “exceptional behaviour from a G7 government bond market”.
Since then, rate expectations have come back slightly, with markets implying there would be no change this year in the headline Bank rate.
Much rests on the price of oil, which has spiked in recent days. Around 20% of the world’s oil travels through the Strait of Hormuz each day, trade that has almost entirely stopped since the start of the conflict.
A barrel of Brent crude has risen above $100 for the first time since 2022, threatening to bring about a spike in inflation across the world.
“A long, protracted war will have a negative impact on longer-term inflation, hence why we have seen yields rise,” said Jones. “It is difficult to predict president [Donald] Trump’s behaviours, comments and moves and this ‘Trump Bingo’ has been going on for a while.”
Gilts have felt the brunt of investors’ ire, however, noted David Roberts, head of fixed income at Nedgroup Investments, with UK government bonds hit hard both in absolute terms and relative to the like of German bunds and US treasuries.
“[This] is the problem of an open economy with a reliance on imported energy and ongoing political concerns,” he said.
“We're not surprised by the move. Shorting gilts is an easy and, to some extent, lazy trade, but can be justified on the basis that a temporary spike in CPI [the consumer prices index] from raised energy prices could stay the Monetary Policy Committee’s (MPC) hand and prevent rate cuts; indeed, there are even some who are forecasting hikes before the end of 2026.”
Inflation remains above the Bank of England’s 2% target, hovering at 3% on the January reading from the Office for National Statistics.
Is now a buying opportunity? The answer is yes
Jones said the long end of the gilt market “looks attractive”, with issuance collapsing and quantitative tightening “massively reduced”.
“Clearly, we have seen significant technical moves, going from overbought on relative strength indicators to oversold very quickly. Fundamentals though are being questioned,” he said.
The co-manager of the Rathbone Strategic Bond fund is also constructive on the shorter end of the curve in the right situation.
“The front end has also seen some aggressive repricing. If you think the inflation fed through is not going to be that bad and a conclusion to this trouble is forthcoming, then clearly there could be a lot of value,” he said.
Roberts, meanwhile, moved from neutral to double weighted last week, citing the short-term relative value to US and German government bonds.
“Also, a sharp upward move in energy prices is way better for sovereign bonds than a protracted month-on-month series of rises. Why? The so called ‘base effect’ means that in a few months' time oil may well be materially lower than current spot prices, meaning disinflationary forces are at work,” he said.
“Put in another way, we went from $60 to $100 [per barrel] almost overnight. If that goes back to $80 by May, the MPC will be able to ‘look through’ the spike and may indeed be more tempted to cut, as CPI in late 2026/into 2027 may perversely undershoot target, depending, of course, on second-round effects such as collective bargaining, triple-lock impact and general pass through to the broader economy.”
Craig Veysey, head of fixed income at Guinness Global Investors, also believes there are reasons for optimism, noting that this is not a “fiscal crisis” nor a repeat of the market frenzy that followed former prime minister Liz Truss’ disastrous mini-Budget.
“This is an inflation repricing story. Safe havens do not work in the usual way when bonds have already rallied hard, yields are near their lows and markets suddenly have to worry about inflation again,” he noted.
“At these levels, I do think gilt yields are becoming attractive again. There is clearly a risk that energy prices stay higher for longer if the conflict drags on and central banks are far too early in the process to react. But if yields move further out of proportion to the underlying UK economic data and/or energy prices begin to stabilise, my bias would be to be a buyer of gilts.”