'Larry the Cat' sits outside 10 Downing Street ahead of a cabinet meeting in London on July 21, 2026, a day after Andy Burnham became Britain's 7th prime minister in 10 years.
The U.K. may have had seven prime ministers since the Brexit referendum in 2016, and it may face a very challenging government budget backdrop, but right now the country's bonds are the more attractive among its peers.
That's according to Daniel von Ahlen, head of macro strategy at TS Lombard, who in a note published Wednesday, says investors should buy 10-year British gilts ahead of equivalent duration U.S. Treasurys, German bunds and Japanese government bonds (JGBs).
A major reason for von Ahlen's call is that he thinks the market is underestimating the relative weakness of the U.K. economy.
And with the prospect of a U.S.-Iran deal reducing one of the key risks to global energy markets, von Ahlen believes investors can refocus on a U.K. economy that is steadily losing momentum rather than one facing another inflation shock.
Markets currently have almost two Bank of England rate hikes priced in by June next year - a move that would tend to be damaging to bond prices and thus push yields higher. But von Ahlen believes that scenario is too hawkish.
"We still think the BoE can cut rates next year," he says, pointing to a labor market that "remains in the doldrums" and evidence suggesting that feared second-round inflation effects from higher energy prices have largely failed to materialize.
Perhaps the strongest support for that view comes from wages, according to von Ahlen. U.K. pay growth has slowed sharply and has now returned to around pre-COVID levels, a marked contrast with economies such as Japan and the eurozone, where wage pressures remain more persistent.
Importantly, businesses also appear relatively relaxed about pricing. Von Ahlen says that the BoE's agents survey shows firms' pricing plans are "effectively unchanged" since the Iran conflict erupted earlier this year, while inflation expectations have eased across a broad range of measures.
Taken together, that leaves a fairly benign domestic backdrop. A "negative output gap, a languishing labor market, soft real income growth and unambiguously restrictive monetary policy should alleviate concerns around sticky underlying inflation in the U.K.," von Ahlen argues.
The implication is that U.K. yields have further room to fall relative to other major government bond markets.
For example, von Ahlen believes there isn't much downside for German bund yields BX:TMBMKDE-10Y from current levels because the European Central Bank is likely to raise borrowing costs two more times in the current cycle amid accelerating wage growth in the bloc.
Similarly, he argues that: "The trajectory of wage growth in Japan continues to imply much higher services inflation over the coming years and, with it, sticky JGB yields."
The difference between the U.S economy and the U.K. is particularly stark. Von Ahlen thinks a strong U.S. labor market means the Federal Reserve should focus on elevated inflation and thus may need to tighten policy again, beginning as soon as September, and followed by four additional rate hikes next year.
For investors weighing relative value in global bond markets, von Ahlen's message is straightforward: if the U.S. is heading for higher rates while Britain is edging toward lower ones, gilts look like the more compelling trade.
-Jamie Chisholm