Partner Content: Robin Creswell from Payden & Rygel on the benefits for local government treasurers of short-term bonds in the current high-inflation environment.
While the buzzword of “inflation” is likely to send shivers down treasurers’ spines, it is a key issue to face head on in order to reduce the effect on local authority cash.
Since the start of the year, yields on short-term bond funds have reached their highest level in over a decade. Yields of 4.4% to 6.8% on short-term bond funds with a duration of 0.9 to 2.5 years have the potential to meaningfully reduce the erosion of treasurers’ cash due to the impact of inflation.
Relative to bank deposits and money market funds, short-term bond funds can provide a complementary tool along with broad diversification of counterparty risk to help maintain the real value of local authority assets.
With two-year gilts yielding 3.46% and the yield curve flat as far out as ten years, after inverting in the second half of last year, markets are anticipating low growth in the UK. Unlike the US, where the Federal Reserve is expected to continue with a hawkish rhetoric and interest rate hikes until inflation truly abates, the Bank of England remains more equivocal.
Governor Andrew Bailey stated: “Some further increase in the Bank rate may turn out to be appropriate, but nothing is decided. The incoming data will add to the overall picture of the economy and the outlook for inflation, and that will inform our policy decisions.”
Cash supplement
While “cash was king” in 2022, this unique year in markets has now provided some very attractive opportunities within fixed-income markets. Treasurers can supplement cash at the bank and money market funds with sterling short-term bond funds, operating with a broader opportunity set, but still with a very high-quality AAAf rating.
Core objectives include capital security, liquidity, and higher yields than those offered by both bank deposits and money market funds.
Moving beyond the more constrained realm of the highest-quality short-term bond funds, but still remaining Investment Grade on average, provides a significantly broader opportunity set and higher yield potential. This can currently be attained with low interest rate risk exposure, with duration typically in the one- to two-year range.
While decisions remain unique to each local authority, by picking their point along the risk/return spectrum, we believe local authority treasurers can benefit significantly from an allocation to short-term bonds.
Robin Creswell is managing director-London for Payden & Rygel.
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