UK gilts are performing better than they have been for decades.
But… gilts might also be just about on the brink of a pullback in their hour of triumph.
And not for the reasons you’d perhaps expect.
As the FT reports on Friday, already-low gilt yields have been brought down further by a mix of fiscal and quantitative easing expectations. These supports might even feed each other to an extent: more cuts = more compensatory QEasing to support the economy. Nomura, for instance, has already argued this week that gilts are set to benefit from institutional and regulatory support, too.
In the long run, that is. Because Nomura also turned on Friday to tactically underweighting gilts, based on a set of intriguing short-term signals.
First — and timely, as all this UK QE speculation flies — the role of the Bank of England and its Asset Purchase Facility:
Despite being obviously spread across a different mix of securities, this represented the equivalent of 85% of overall issuance [£227.6bn in 2009/10]. While the possibility of a further QE helping hand in 2010/11 is not completely off the agenda, we still see it as unlikely given what we view as a more balanced run of recent commentary than perhaps is being reported. In that sense we think it worth focusing on the “naked” (net of BoE) issuance burden over the fiscal year, with a record amount of supply actually being taken down in those terms. Moreover, when lined up with 2009/10 in isolation, the figure is picking up by some £122bn and is loaded much more to the longer end than the raw figures would imply.
Now, the counter to this is that QE will happen and MPC members are already coming off the fence. The counter-counter of course is that the QE proposed so far — £50bn — can’t really support gilts that much.
There’s another technical issue of over-supply worth pointing out. This is connected to Debt Management Office efficiency in getting great deals of its allotted issuance out of the way early in the year, something we’ve noted before.
According to Nomura, this early efficiency is perhaps going to keep buyers away from the market for the near future:
Some larger-than-expected syndications in the early part of the year and the extent to which the DMO was able to run ahead of its mandate were responsible for much of the positivity on the long end, on anticipation of a slowing issuance burden further down the line. However, with hindsight perhaps a more backward-looking focus was in order, with the curve performance a possible indication that the scale of those early forays has left an excess legacy…
This might be one reason why 30-year gilts haven’t joined the current rally; in fact, they’re at a record yield spread to 10-year gilts, as you can see in the below Bloomberg chart:
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Of course, Nomura’s doubts — and remember that this is just a tactical underweighting — all derive from the unique quirks of institutional demand for gilts:
At this stage this is a tactical call rather than a strategic one in outright terms with the broader framework of macro uncertainty, deleveraging processes and regulatory reform still very much in place and set to limit the scope for a more major bearish breakout. However, with yields tracking at historical extremes we believe the tactical potential is more significant than usual and we would view any further strength, particularly through next week’s 30-year syndication as an opportunity to fade…
Finally — Nomura have one more spot of gilt doubt to consider (click to enlarge charts):
Another source of concern for us is the pattern of recent auction performance with our bid to cover index for the UK having deteriorated significantly over the past few months. This could be indicative of a looming turn – for example, our European series downshifted in the lead-up to this spring’s sovereign debt crisis. That said, we do not want to overplay the linkages here, suffice to say that the latest trend adds to our growing circumspection…
Worthwhile pointing out here too that the dynamics of bid covers work somewhat differently in gilt auctions compared to those for (say) Irish or Greek bonds, which could make comparison difficult.
Nomura’s right that this is one to watch, though.
Related links:
A record GBPEUR 2-yr swap spread - FT Alphaville
More gilt-free bloodshed - FT Alphaville
The BoE behind closed doors - FT Alphaville