UK debt: Hot cakes or hot potatoes?
Wednesday’s successful gilt auction prompted a wave of patriotic commentary. This, for instance, is from The Independent’s David Prosser who says Britain’s bonds are literally selling like warm pastries:
Outlook So much for Britain’s lack of creditworthiness. The Debt Management Office yesterday staged its first sale of gilts in 2010, auctioning £4bn of short-term government borrowing. With Pimco, the world’s largest bond fund, this week warning that it plans to trim its exposure to the UK this year given its view that we are 80 per cent likely to see a credit rating downgrade, no doubt investors were few and far between? Well, no, actually. Total bids during the auction totalled £10bn.
As FT Alphaville wrote on Wednesday, echoing the thoughts of Monument Securities gilt-specialist Marc Ostwald, this particular auction had a few `special features’ to support it.
And on Thursday, Ostwald is hammering those points home:
Rarely in my years covering Gilts have I seen so much ill-informed opinion expressed in the media about the success of yesterday’s 2.75% 2015 auction. So much of the comment focuses on how it flew in the face of the negative Gilt views expressed by the likes of PIMCO, BlackRock and Standard Life, to mention but a few.
The truth about the demand was as we suggested yesterday:
a) bank capital balance sheet demand
b) it’s a sub-par 5-year bond, with a yield of 3.0%, it was very cheap to its peer group, and given the steepness at the front of the curve, it is THE ideal Gilt for the old principle of using ultra low short-term rates and a steep curve to re-capitalize the banking sector in times of financial sector distress. Oh and by the way it’s also the new 5-yr benchmark (doh!)
c) the added bonus for GEMMs of being able to offload a large amount of the stock that they would have had to buy from end investors and specs switching into the 2.755 2015 was more than well evidenced by the 3.92X cover ratio at the afternoon 3-10 yr QE auction, where all but £42 Mln of the £1.7 Bln that the BoE bought was in the stocks immediately surrounding (2013-2015) the auction stock.
d) Other than for their ultra short funds, this is not really an area that commercial fund managers are buyers of, while most pension fund managers have duration index targets of 15yrs plus, so this was not one for them either.
e) Take a look at the attached Gilt deviations sheet, and the the way that the Gilt curve between 5 and 50 years steepened by 6 bps yesterday, and now tell me whether these long term fund managers are enthusiastic about long-dated Gilt yields – I think NOT!
The real test of demand for gilts is now widely expected to come next Wednesday, with the £2.25bn 4.25 per cent 2049 auction. That particular offering has fewer of the supportive traits of this week’s one.
Notably, these are longer-dated bonds and investors may well want to be demand a higher concession in return for taking on that higher (longer) risk.
As Ostwald notes:
It is after all still a travesty that the 10/30 yr Bund spread is 75 bps, the 10/30 yr US Treasury spread is 86 bps, while the 10/30 yr Gilt spread is 35 bps and the 10/50yr Gilt spread is 25 bps.
Related links:
Treasury committee says UK may not be able to sell enough gilts – Telegraph
Risk-free status of government bonds comes under scrutiny – FT
Consolidating the US, UK gov’t bond sell-off – FT Alphaville