By Anthony Gillham, portfolio manager for Skandia Investment Group
The last few years have bucked the tradition of a quiet summer in the square mile and we all thought Summer 2012 was going to follow this recent trend. But despite the turbulence in Europe, London has felt relatively quiet as the markets have managed to hold on to some form of stability.
Yet over the past month, bond markets haven't behaved as though they're on holiday. Credit spreads from sovereigns, to corporate investment grade, to high yield have rallied, but what really caught my eye is the behaviour of so called government safe havens.
Over recent weeks, yields have moved out nearly 0.5% in the US as measured at the 10 year point on the curve and now stand 0.1% higher than UK gilts. This might not sound much, but this difference, or basis, has shifted significantly over the past few weeks meaning that UK gilts now yield less than "ultra safe" US government bonds.
Both pieces of data are significant. Bond yields moving higher are often correlated with improving economic data, which is what we have observed in the US. That gilts have out performed US treasuries further supports the perceptions about the relative state of the two economies.
However, of greater interest is what the relationship between US treasuries and Gilts has told us about risk appetite in the past. Looking back through time, the UK/US government bond spread has behaved like a proxy for risk. One explanation for this is that the US government bond market is more flow driven than the UK and we are seeing investors dump negative real yields in government bonds in favour of riskier assets like credit and equities.
There are signs amongst UK survey and employment data that the indicated recession might not be all that it seems which could mean Gilts catch up. Whilst there are number of negatives floating around such as the US fiscal cliff, with the macro data picking up, and the European situation holding together as markets smell a plan, the environment for risk is looking somewhat brighter than it did a few short months ago.
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