Gilts are in a vulnerable spot, with consequences for government borrowing and spending.
- Hedge funds and foreign creditors have replaced “patient” investors such as pension funds
- Turbulence in global bond markets has raised the cost of long-term borrowing
- A long-dated gilt issued in mid-May came with a coupon of 5.375%
While its overall verdict on the UK economy was a tentative thumbs up, the IMF warned this week that UK government debt was particularly vulnerable to sudden sell-offs. Hedge funds and foreign creditors in the bond market have replaced “patient” investors such as pension funds and insurers as holders of longer-dated bonds.
It is another problem for the unpredictable cost of UK debt. The UK government has been forced to issue shorter-dated debt as turbulence in global bond markets has raised the cost of long-term borrowing. This was demonstrated by a long-dated gilt issued in mid-May, which came with a coupon of 5.375% until January 2056.
RBC Capital Markets research showed that the gilts being issued between July and September this year will have an average maturity of around nine years against an average of 14 years. In theory, there is no problem with shorter-dated debt, but it does leave the government more vulnerable to shifts in interest rate expectations.
Gilts are suffering both because of home-grown and international problems. Yields have been steadily rising because of the UK’s weak fiscal position. Government borrowing in April hit £20.2bn, ahead of the forecast £17.9bn and in spite of rising tax receipts from the National Insurance hike. The main problem was higher spending commitments because of inflationary rises in benefits.
The volatility in the US bond market is also hurting UK borrowing costs. The yield on American government bonds remains the global benchmark for borrowing costs, so UK policymakers cannot escape the erratic policymaking of the US administration. Its impact on the Treasury market reverberates around the world.
While this should make gilts more attractive, fixed income investors are still uncertain. Schroders says: “Gilts valuations in isolation are somewhat attractive, but near-term inflation uncertainties restrain our optimism for now”, while Oxford Economics says: “We continue to shun long-end gilts. They remain a case in point of what to avoid despite our belief that the Bank of England will cuts rates by more than market pricing on the back of weaker growth and lower inflation.”
The wobbliness of the bond market adds to the general precariousness of the UK government’s finances. It also removes an option for Rachel Reeves – it would be a very dangerous moment to mess with the fiscal rules. While none of these problems are new, they have been stubbornly persistent and add to a murky outlook for the UK economy.
