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8 November 2013 last updated
UK annuities could rise as market expects Fed to taper stimulus

UK annuities are more likely to rise as the latest US jobs data was better than expected increasing the chance of the Federal Reserve to start tapering the stimulus package from December and sending gilt yields higher.

15-year gilt yields have increased 9 basis points to 3.20% after the US added 204,000 jobs when the markets expected the figure to be 120,000.

In addition to the jobs data US economic growth was also well above expectations at 2.8% in the third quarter improving the chance the Federal Reserve will consider tapering the $85 billion per month stimulus package.

As a general rule a 9 basis point rise in yields would result in a 0.9% rise in annuity rates. Yields had reduced to 2.97% at the end of last month and have rapidly improved by 23 basis points in the last week.

Investors had bet that the Fed would delay tapering until the summer of 2014 but have started to sell bonds and gilts in case this starts in December.

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Annuities will improve if tapering started

The markets have invested heavily in bonds and gilts since the financial crisis began sending prices up to over inflated levels helped by the US stimulus package. The 15-year gilt yields reached a low of 2.02% in August 2012 and recovered to 3.38% by September in anticipation of tapering to start. The chart below shows how annuity rates and the 15-year gilt yields have changed since July 2008.

Annuities vs gilt yields
Fig 1: Chart comparing annuity rates and 15-year gilt yields

Gilt yields have now improved by 113 basis points since the end of August last year although annuity rates are higher by only 6.7% suggesting there is room for a 4.5% rise in annuity rates in the medium term. Both yields and rates are significantly below the levels before the financial crisis in July 2008 and UK annuities could still improve 22.5% over the long term, possible 5 to 8 years.

Important indicators for future gilt yields

The decision by the Federal Reserve to delay tapering resulted in a fall in yields and annuity rates. The longer the $85 billion per month of Quantitative Easing continues the more convinced investors are that nothing will change until the summer of 2014.

More positive economic data with the US growing by 2.8% in the third quarter and better than expected jobs figures mean tapering is back on the agenda and could occur to some degree from December although the economy may not be strong enough to stop tapering, some minor tapering measures could be warranted.

Unemployment in the US actually increased from 7.2% to 7.3% even though more jobs were added and is thought to be due to the government employees forced to stop working while the debt ceiling deal was being negotiated.

Interest rates are not expected to rise until unemployment falls to 6.5% in the US and in the UK the trigger will be 7.0% and expected to be reached earlier than expected in 2015.

Gilt yields and hence UK annuities are poised for a rise so long as economic data remains positive and the expectation is that US tapering of stimulus is likely to occur before next summer. Interest rates in the UK are also expected to rise earlier than the target set by the Governor of the Bank of England Mark Carney's new "forward guidance" policy to freeze interest rates at 0.5% until mid 2016.

News related stories:
Annuity rates increase up to 2.8% from Legal & General
Annuities boost as market defies Bank of England rate freeze
Pension annuity income risk as Bank of England may start QE again
Retirement annuities threat as yields fall on UK and US stimulus plans
Related internet links:
Telegraph - US Growth continues as jobs beat expectation
Guardian - Upbeat US jobs data suggests December tapering
Guardian - Rise in US economic growth tapering now in focus
Telegraph - US economic growth smashes estimates
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