all investors were bearish
and yet this was the very
point to turn bullish; and
conversely at the peak of a
bull market, bears are hard
to find. The key point here
is that everyone can see
the reasons for being negative
on the gilt market. So
perhaps the UK gilt market
in 2010 will not be such a
bad place to be after all.
l Paying the debt
Racking up debt is one thing,
but paying for it is another.
For the UK Government,
the massive reduction in
interest rates has made debt
cheap and data from the
Debt Management Office
shows that UK Government
debt interest payment is
expected to be no higher
in 2009-10 than at the start
of the decade, indeed the
debt interest payments over
the past ten years have
been remarkably stable. So
paying the interest is not an
issue. What is more, as the
recovery gains ground the
tax take will rise (see gilt
interest table on page 58).
When the Bank of
England announced its
quantitative easing programme
there was a view
that such demand would
push yields to very low
levels, as low as 2.5% on
ten-year gilts, but this did
not happen. There was a
clear spike in many gilt
prices shortly after the
announcement, but since
March 2009 the trend has
broadly been for prices
to either fall or trade sideways.
So if there was not
the up-side, perhaps there
will not be the anticipated
downside.
Irrespective of the consensus
view on gilts, it is
increasingly accepted that
the FSA will require banks,
both UK and foreign, to
hold more liquid assets.
These assets are most likely
to be UK gilts, as such the
gilt purchasing programme
of the Bank of England
could get passed on, just
like a baton in a relay
race. So although there is
£176bn of issuance to come
in 2010, buyers may not be
in short supply.
l The lost decade
Additionally, if the consensus
was right, it would not
be unreasonable to expect
the Debt Management
Office to have struggled
to issue new gilts if the
outlook for them was so
poor. In fact, at times the
inference from some quarters
has been that the Bank
of England has been the
only buyer in town. But
gilt auctions remain over
subscribed.
The Treasury 3.75%
Gilts in issue and 10-year gilt yield
80
70
60
% 50
40
30
10-year gilt yield
20
Apr ’98 Jan ’00 Jan ’02 Jan ’04 Jan ’06
Source: Morningstar; Debt Management Office
Issuance scale
Jan ’08
Jan ’10
Gilt market issuance
240
120
200 Gross issuance
100
160 Net issuance
80
120
%
80
Net debt/GDP %
60
%
40
40
20
0
0
-40
-20
’90-’91
’92-’93
2019 issued in January
2010 was 2.38x covered;
the 4.25% Treasury 2049
was 1.81x covered; the
2.75% Treasury gilt 2015
was 2.68x covered. These
were not an exception. So
there has not been a shortage
of investors wanting to
buy gilts. Pension funds,
for example, have to keep
matching their liabilities
and income streams; an
issue that is probably getting
more urgent.
There is also circumspect
evidence from the FTSE All
Stocks index (TR). In the
past ten years, this index
has only had one negative
year, 2009. This period is
now being referred to as
the ‘lost decade for equities’,
it covers the end of
the technology boom, the
market collapse and the
subsequent (mild) recession
and strong recovery.
That is not to say the
gilt market cannot have
a second negative year,
it can, but the data from
the past ten years suggests
positioning for this would
be against the trend.
Interest rates seem very
likely to remain low for
much if not all of 2010,
and as such a return of
4% against a base rate of
0.5% is by most standards
attractive. Inflation
could prove tricky for the
Bank of England to deal
THE CONTRARIAN GILTS
SUMMARY
There remains a very real
threat that the rating agencies
could downgrade the credit
status of the UK, and this
issue will rise up the political
agenda as we approach a
general election.
There is £176bn of projected
issuance to come in 2010,
though buyers may not be in
short supply if banks are made
to hold more liquid assets.
In the past ten years the FTSE
All Stocks index (TR) has only
had one negative year, 2009.
MARCH 2010 [www.portfolio-adviser.com] PORTFOLIO ADVISER
’94-’95
’96-’97
’98-’99
’00-’01
’02-’03
’04-’05
’06-’07
’08-’09
’10-’11
’12-’13
’14-’15
Source: Debt Management Office. Data from current financial year
onwards are projections, while earlier data are the historical figures.
with, but if the inflationary
pick-up is temporary,
as it appears likely it will
be, the yield on gilts will
remain attractive for risk
averse investors.
l Contracting supply
One of the big hopes for
quantitative easing was
that the money supply
(M4 – broad money)
would expand, but it has
proved quite resistant to
expansion.
This remains a concern
for the MPC as a contracting
money supply could
be very damaging. M4 has
expanded but at a disappointing
rate, so the MPC
will need to find ways
to further stimulate the
money supply and this just
might mean more support
for the gilt market.
Even the argument about
supply and demand has to
be questioned because the
evidence suggests there
is no strong relationship
between issuance of gilts
and their price and yield
(see graph above).
As those making up the
consensus will tell you,
there are good reasons to
expect gilt yields to rise
– but there are equally
good reasons to question
this, and experience shows
that the consensus is often
not right in the end.
Inflation could
prove tricky for the
Bank of England to
deal with, but if the
inflationary pick-up
is temporary, as it
appears likely it will
be, the yield on gilts
will remain attractive
for risk averse
investors
“
”
59
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