A deluge of gilt issuance is expected in coming years as the UK government is forced into fiscal def...
A deluge of gilt issuance is expected in coming years as the UK government is forced into fiscal deficit to meet spending commitments.
Andrew Roberts, fixed income strategy director at Merrill Lynch, views the Treasury's 2003-4 gilt funding requirement of £40bn as the start of a structural shift.
'There is an absolute slew of funding to come, with more than £35bn in gilt requirements from each of the three financial years after 2003-4 alone,' says Roberts.
'Against £26bn last year, £13bn the year before that and £10bn the year before that, we can see this as structural, not cyclical. It is enormous expansion with totally unprecedented numbers.'
In addition to the gilt debt, Network Rail will soon be raising £6bn in the bond markets while Metronet and Tubelines are set to raise £1bn each for refinancing London Underground, Roberts points out.
Despite crowding-out risks, he believes the market will be able to digest the glut of issuance. But, he says: 'Demand will only be there at higher yield levels with bigger concessions.'
The new funding calendar supports further UK underperformance throughout the bond curve against European bond markets, says Roberts. Relative to Europe, he forecasts, Merrill Lynch will remain very negative on UK gilts regardless of the outcome of war in Iraq.
'But on an absolute basis, it is difficult because we feel there are still very major downside risks to the economy,' he adds.
'Never mind any post-war confidence rally, the economic fundamentals do not add up. They look absolutely awful. Iraq is not pivotal; it is not a main economic event, it is a geopolitical sideshow.'
The Treasury Debt Management Office announced earlier this month the new issuance would be comprised of £13.4bn in shorts, £10.8bn in medium-term bonds, £9.3bn in long-dated bonds and £6.5bn in index-linked paper. Kevin Adams, Credit Suisse Asset Management UK fixed income director, says the breakdown shows the Treasury has listened to the markets and refrained from overburdening the index-linked sector.
Conventional gilt issuance has been shifted in favour of short-dated bonds, he notes, with enormous demand for long maturities having abated somewhat.
He attributes this to the minimum funding requirement on pension funds being phased out and life insurers having effected most of their hedging on guaranteed annuities liabilities.
Typically, says Adams, the UK market is less efficient at digesting new gilt supplies than the US and European markets. Nimble tactical investors should therefore be able to make small profits by selling short in the week before the new gilt auctions and replacing their holdings at slightly cheaper prices during the auctions, he adds.
Credit Suisse intends to stay relatively neutral on UK gilts, according to Adams. Unless an investor believes they have some significant insight into the geopolitical future, he says, 'the prudent way is to stay close to base'.
Roberts adds the Government has heavily loaded shorts at 40% of issuance because gilt redemptions for 2003-4 will be £21bn, the largest in more than 10 years.
'That money will be looking for a home, so they have had to issue a lot of shorts,' he says. 'As for longs and index-linked, it was inevitable we were going to have increases because the Government has a lot of funding to do.'
Glut of issuance forcing up yields.
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Tactical profits window from pre-auction sales.
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Scope for change post-Brexit
To tackle liquidity issues