UK pension schemes holding gilts have been urged to take stock, after market indicators showed potential signs of looming gilt sell-off.

LCP partner, Alex Waite, argued that the UK Bond Market is in "unprecedented territory" with an extremely low gap between corporate bond yields and government bond yields coupled with a large gap between the government bond yields and swap yields.

Waite suggested that this could reflect a market expectation of a considerable offload of gilts by pension schemes, explaining that anticipation of the sell-off would naturally drive down gilt prices and hence elevate yields.

"My hypothesis here is that the market is bracing for a considerable offload of gilts by their principal holders – UK pension schemes and the Bank of England," he explained.

"The anticipated sell-off would naturally drive down gilt prices and hence elevate yields, potentially accounting for the observed circa 0.5 per cent pa discrepancy relative to other markets."

Waite also clarified that while there are a number factors at play, in both the UK and internationally, such as increasing confidence in the economic outlook as inflation starts to get under control, there also appears to be some UK effect in the numbers which could be explained by this anticipated sell-off.

Whilst Waite accepted that it is unlikely that gilt yields are being pushed up by major market fears of a UK Government default, he argued that there is a market risk of resale before redemption that is steering market sentiments, overshadowing the negligible default risk.

And with market sentiment indicating a shift, Waite suggested that the reputation that the gilt yield has as the de facto benchmark for the long-term ‘risk-free’ rate could be due for reassessment.

He stated: “For investors and pension schemes with a strategy to hold their gilt portfolio to maturity, the gilt yield arguably remains a reliable indicator of the 'risk-free' rate that they can expect to receive.

"However, the billion-pound question remains: Will pension schemes stay the course to redemption? If market sentiment indicates a shift, the gilt yield's reputation in the pensions industry as the de facto benchmark for the long-term 'risk-free' rate could well be due for a reassessment.

"As we step into the new year, it's clear that, while the UK government's commitment to honouring gilt coupons is not in question, the market participants' commitment to holding these instruments might well be.

"It's a pivotal moment for pension schemes to take stock – the gilt yield indicator is more than just a number; it's a narrative of market anticipation and pension strategy stability.”

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