March 2018 Yield Market Update

Yield update

Historic yield movements – 31 March 2018Real yields 20 Year Real Gilt Yields – April 2016 to date

(2.0)

(1.6)

(1.2)

(0.8)

(0.4)

0.0

Apr

16

May

16

Jun

16Ju

l 16

Aug

16

Sep

16

Oct

16

Nov

16

Dec

16

Jan

17Fe

b 17

Mar

17

Apr

17

May

17

Jun

17Ju

l 17

Aug

17

Sep

17

Oct

17

Nov

17

Dec

17

Jan

18Fe

b 18

Mar

18

Yie

ld (%

)

Real yields fell by 16bps over March, sitting at -1.70% as at the end of the month.Br

exit

1.01.21.41.61.82.02.22.42.62.8

Apr

16

May

16

Jun

16Ju

l 16

Aug

16

Sep

16

Oct

16

Nov

16

Dec

16

Jan

17Fe

b 17

Mar

17

Apr

17

May

17

Jun

17Ju

l 17

Aug

17

Sep

17

Oct

17

Nov

17

Dec

17

Jan

18Fe

b 18

Mar

18

Yie

ld (%

)

3.0

Source: Bank of England

Interest rates20 year nominal gilt yields – April 2016 to date

Long-dated nominal yields fell 22bps over March, standing at 1.76% as at end of the month.Br

exit

Source: Bank of England

Inflation20 year implied inflation – April 2016 to date

2.0

2.4

2.8

3.2

3.6

4.0

Apr

16

May

16

Jun

16Ju

l 16

Aug

16

Sep

16

Oct

16

Nov

16

Dec

16

Jan

17Fe

b 17

Mar

17

Apr

17

May

17

Jun

17Ju

l 17

Aug

17

Sep

17

Oct

17

Nov

17

Dec

17

Jan

18Fe

b 18

Mar

18

Long-term inflation expectations ended the month at 3.46%.

Brex

it

Source: Bank of England

Summary

— Nominal and real yields fell sharply over March 2018 on the back of fears over an escalating US-China trade war, and heightened geopolitical tensions. A general risk-off tone led investors to seek safe haven assets, as equity markets sold off over the month.

— Volatility was seen in both outright rates markets and across the curve. The real and nominal curves flattened further on news that there would be fewer syndications over the coming fiscal year, although some steepening returned as 10Y rates rall ied most strongly from the fl ight to safety at month end.

— Expected inflation sold off approximately 6bps, as the February CPI print fell 0.3%, coming in behind expectations, owing to a slowdown in import price inflation.

— Long-dated (20 year) real yields are currently standing at -1.70% as at the end of the month. Contributing to this: - Long dated nominal yields stood at 1.76% at end of March;- Long dated inflation expectations fell to 3.46%.

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2

Yield update

Looking forwardUK interest rates – Forward curv es31 March 2018

0.0%

0.5%

1.0%

1.5%

2.0%

2.5%

3.0%

0.5 5.5 10.5 15.5 20.5Spot 1yr Fwd 3yr Fwd 5yr Fwd 10yr Fwd

The upwards sloping yield curve continues to imply that rates will rise going forward…

… The question is, wil l they rise as fast as has been priced in?

Source: Bank of England & KPMG analysis

Base rateImplied base rate trajectory – 31 March 2018

0.0%

0.5%

1.0%

1.5%

2.0%

2.5%

3.0%

0.5 5.5 10.5 15.5 20.5

We can plot the expected trajectory for the UK base rate

Source: Bank of England & KPMG analysis

Interest rates – Today v ersus implied position in 3 years timeImplied yield curve in 3 years – win lose or draw?

0.0%

0.5%

1.0%

1.5%

2.0%

2.5%

0.5Spot 3yr Fwd

5.5 10.5 15.5 20.5

© 2018 KPMG LLP, a UK limited liability partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.

Document Classification: KPMG Public

3

Lose

Rising interest rates will only impact pension scheme valuations positively if the realised yields are above the position already ‘priced in’.

Win

The market has priced in a degree of interest rate rises – the chart highlights the expected yield curve position in 3 years time.

Source: Bank of England & KPMG analysis

Summary

— The UK forward curve continues to slope upwards – implying that interest rates will rise going forward. We can identify the pace of these increases by looking at the forward curves.

— A subtle, but important, point is that rates have to rise above the market expectation to impact valuations positively.

— In terms of the impact of pension scheme valuations:- Win: yields in 3 years time higher than already priced in (by 3 year

forward curve);- Draw : yields move up in l ine with markets expectation (i.e. follows

forward curve);- Lose: Yields don’t increase to meet the market’s expected position.

Yield update

Analysis of changeMonthly yield movementsYield movements over past 12 months

12 months Nom Real Inf

April 2017 0.00 (0.06) 0.06May 2017 (0.04) 0.08 (0.12)June 2017 0.18 0.14 0.03July 2017 (0.01) 0.05 (0.06)August 2017 (0.16) (0.20) 0.04September 2017 0.24 0.23 0.01October 2017 (0.01) (0.01) 0.01November 2017 (0.06) (0.05) (0.01)December 2017 (0.13) (0.11) (0.01)January 2018 0.16 0.13 0.03February 2018 (0.01) 0.04 (0.05)March 2018 (0.22) (0.16) (0.06)

Note: All movements quoted in percentage points change over the period.Source: Bank of England & KPMG analysis

Quarterly yield movementsYield movements over 2018

Period Nom Real Inf

Q1 (0.07) 0.01 (0.08)Q2 - - -Q3 - - -Q4 - - -YTD (0.07) 0.01 (0.08)

Summary analysisYield movements over past 12 months

12 months Nom Real Inf

Max 2.12 (1.43) 3.76Min 1.71 (1.98) 3.43

Longer term analysis

Period Nom Real Inf

3 months (0.07) 0.01 (0.08)6 months (0.26) (0.17) (0.10)1 year (0.06) 0.07 (0.14)3 years (0.53) (0.77) 0.245 years (1.34) (1.27) (0.07)

© 2018 KPMG LLP, a UK limited liability partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.

Document Classification: KPMG Public

4

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© 2018 KPMG LLP, a UK limited liability partnership and a member f irm of the KPMG netw ork of independent member f irms aff iliated w ith KPMG International Cooperative (“KPMG International”), a Sw iss entity. All rights reserved.

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