LDI chart update: What could rising yields mean for DB schemes?

Gilt and index-linked gilt yields now stand at, or close to, 20-year highs. At a headline level:

• 10-year gilt yields rose by just over 1% in 2024. This is the seventh-highest calendar year move based on data since 1979 (2022 was 2.7%). Over Q4 2024, 10-year gilts moved higher by 0.56%. In 2025, 10-year gilt yields have risen a further 0.23% to 8 January
• On 8 January 2025, 30-year index-linked gilt yields closed above 2%. This surpasses the highest closing yield in September 2022 (but not the highest intra-day yield)
• On 7 January 2025, 30-year gilts were auctioned at a yield of 5.2%. This is the highest level for a 30-year auction since May 1998

Despite these high levels, markets remain orderly. The magnitude of daily and intra-day moves in yields to date has been far lower than we saw around the 2022 mini-Budget. 

Why have yields risen?

Rather than a single driver, there have been several contributory factors, including:

US influence: Increases in US treasury yields, albeit for different reasons, and a strong US dollar have added to this pressure on UK yields – gilt yields have moved up broadly in parallel with treasury yields since the start of Q4

Supply: 2024 was the first calendar year in the UK where gross gilt issuance net of asset purchases/sales exceeded £300bn. January typically sees higher supply and in 2025 we have seen significant supply of bonds across corporates, sovereigns and supranationals, as well as gilts

Fiscal: Budget overhang and poor sentiment: Expectations of gilt issuance were revised significantly higher following the October Budget. A cumulative increase of £139bn[1] was forecast out to 2028-29. Concerns around the achievability of the government’s growth agenda have led to questions about whether their fiscal rules will be met. This, in turn, has called in to question whether further action will be required. Further tax rises and spending cuts are not seen as palatable due to their impact on growth, while additional borrowing would also be likely to be unwelcome 

Data: Hard data has not been positive for the UK. Growth has come in lower than forecasts and inflation remains high; the latest services inflation print was 5% year-on-year and core CPI was 3.5%. As a result, rate cuts have been priced out. The market is now pricing in two cuts to 4.25% by the end of 2025. Six months ago, an additional 0.5 – 0.75% reduction was priced into markets

Where next?

We view the outlook as relatively uncertain, with risks in both directions for gilt yields. Below we set out potential drivers of both higher and lower moves:

↑ Higher still: Markets often exhibit a tendency to ‘trend’.  All of these factors above, in particular sentiment, can continue to run:

• Heavy global issuance in January
• Continued negative media around UK fiscal rules, fiscal situation and the March Spring Statement 
• There remains scope for markets to price in even fewer base rate cuts

↓ Going lower: How far are we from ‘peak’ bad news? What could make things worse in the short term?

• Conversely, base rates could fall faster than expected if data becomes more supportive
• If heavy seasonal global supply begins to subside and the story passes, that may give room for yields to perform
• Historically yields have tended to fall during the rate-cutting cycle (in contrast to what we have seen in the UK and US)
• We believe that yields are attractive on a long-term basis, which may potentially attract buyers

↕ Wildcards 

• Donald Trump’s inauguration is on 20 January. There is an expectation that executive orders will be used to effect immediate change: there is some uncertainty around this
• An equity wobble could result in yields falling amid risk-off sentiment

What are the implications for DB portfolios?

For DB schemes that are less than 100% hedged, we believe that current levels remain attractive to consider increasing hedging. Schemes should also factor in the potential for further market moves when they consider hedging increases.

'Collateral waterfalls’ can allow for LDI portfolios to be automatically replenished from other liquid assets and remain a useful governance tool to manage leverage. Schemes who have called on those assets may wish to consider the implications of further yield increases on their available assets, and how those funds might be replenished.

 

If you’ve enjoyed this content, we’d like to highlight that you can find all our latest content for DB schemes in one place at our designated DB blog page. 

As a reminder our clients and their advisers can access their collateral sufficiency metrics (and more) on a daily basis on our online portal, LGIM Connect.

Key risks

Past performance is not a guide to the future. The value of an investment and any income taken from it is not guaranteed and can go down as well as up, and the investor may get back less than the original amount invested.

Views expressed are of Legal & General Investment Management Limited as at 8 January 2025. All data sourced by LGIM from LSEG, as at 8 January 2025. Forward-looking statements are, by their nature, subject to significant risks and uncertainties and are based on internal forecasts and assumptions and should not be relied upon. There is no guarantee that any forecasts made will come to pass. Nothing contained herein constitutes investment, legal, tax or other advice nor is it to be solely relied on in making an investment or other decision.

[1] Source: DMO data 30 October 2024