Inflationary fears due to ongoing tensions in the Middle East have caused gilt yields to spike to levels not seen since the aftermath of the Liz Truss mini-Budget sell-off in 2022.
However pension experts are offering reassurance that this is unlikely to cause the same difficulties in the DB market, due to amendments to the way schemes now manage liability-driven investment (LDI) strategies.
The ongoing conflict between the US and Iran has caused widespread market volatility, with share prices falling and bond yields rising significantly in early trading this morning, although these positions reversed after President Trump announced he is “postponing” strikes on Iran’s power plants.
Most notable has been the sharp rise in bond and gilt yields since the US launched attacks on Iran. This has been driven by higher oil prices stoking fears that inflation will rise, and could lead to central banks raising interest rates.
But LCP partner David Wrigley says this should not have the same impact on DB schemes that the sudden spike in gilt prices had in 2022.
“For many defined benefit pension schemes, changes in gilt yields aren’t the big events they used to be. Most schemes have high hedge ratios, with changes in asset and liability values broadly offsetting each other. Hedges are now very well-capitalised in the main, with schemes and LDI funds able to withstand much higher levels of gilt market volatility.”
In 2022 many schemes were forced to sell gilt holdings in a falling market to try to maintain these funding levels, driving further price fall, and forcing more schemes to sell assets.
Wrigley adds: “If the rise in gilt yields is sustained or continues, we will see some asset rebalancing into LDI to top up prudent buffers. In particular, schemes will need to be careful not to be forced sellers of assets that may have recently experienced a price dip. And schemes with a well-diversified pool of assets to draw upon will likely fare better.”
He says: “The impact for many schemes of rising gilt yields will be muted by rising inflation expectations, with pension schemes grateful for their high inflation-hedge ratios. Regardless of how the conflict unfolds in the coming days and weeks, the permanent damage to infrastructure will likely have inflationary effects and likely cause increases to inflation-linked pension payments. However, with some of these inflationary increases capped, trustees of DB schemes will be reassessing their inflation hedges to ensure they remain fit for purpose in a higher inflationary environment. The likely market reaction will be for some schemes to reduce some of their inflation hedges, helping to keep a lid on the cost of hedging inflation and avoiding any spiral effects.”
Fidelity International’s investment director Tom Stevenson says that Trump’s latest U-turn has “triggered gyrations in global financial markets”.
He says: “After heavy falls across bonds, shares and precious metals early on Monday, markets quickly regained their composure after threats to attack Iran’s power networks were abruptly withdrawn via a Presidential post on Truth Social.”
But he adds that while a temporary ceasefire may be positive news for stock market, there are still concerns about inflation, caused by the damage to oil infrastructure to doubt, which is having an ongoing effect on bond prices.
Stevenson adds: “Bond yields are still rising around the world, but nowhere more so than in the UK, where investors have moved to price in four quarter point interest rate hikes in 2026, a significant reversal from expectations just a month or so ago that the cost of borrowing would fall during the rest of this year.
“Bond yields move inversely to bond prices, so rising yields represent capital losses for fixed income investors.
“The 10-year gilt yield climbed above 5 per cent on Monday morning, taking borrowing costs to their highest level since the financial crisis in 2008. Since the Middle East conflict began at the start of March, the 10-year yield has risen by 0.8 percentage points. That puts it on track for the worst month since the Liz Truss mini-budget crisis in 2022.
“Surging energy prices have fuelled fears that the UK could be facing a period of stagflation. This is a challenging environment for policy makers, because high inflation prevents the Bank of England from cutting interest rates to support the economy. For the government, it means an unhelpful combination of high funding costs for its debts alongside reduced tax revenues as growth slows.”