The International Monetary Fund recently confirmed that the UK will be the fastest growing major economy (G7) in 2016, and retracted its earlier prediction of a Brexit induced recession and stock market crash. It is clear that the journey out of the European Union will present challenges along the way, as evidenced by sterling’s “flash crash” earlier in the month. However, Theresa May has shown strong leadership since taking over as Prime Minister and is committed to negotiating an orderly exit plan that protects the long-term interests of the country.

The rally in the gilt market over the last decade has driven yields and corporate bond spreads to the lowest on record, and the risk-reward trade off for holding debt securities yielding less than one percent is extremely poor. The upside is limited and the downside is significant in light of the fact that real yields (yield-to-maturity less the inflation rate) are negative across much of the government curve. This will only get worse given that the annual inflation as measured by the Consumer Price Index has risen to 0.60%, and is set to climb further following the recent deprecation of sterling. To make matters even more problematic, the supply of gilts is going to rise with the government’s pledge to increase spending on productivity-enhancing infrastructure projects in the upcoming Autumn Statement.

The timing of the inevitable sell-off is extremely difficult to predict. However, it’s clear that much of the bond friendly news that has fuelled this rally is now fully priced into the gilt market. It’s theoretically possible for inflation to fall, gilt issuance to decline and economic “Armageddon” to descend upon the UK, but this is not very likely.