Investors have started to panic about rising gilt yields, but is the problem as bad as it looks?
- Long bond yields have spiked in recent days, potentially leaving the Chancellor with an even bigger hole to fill
- There are structurally problems for long-dated UK bonds, with a lack of buyers.
- A pause in quantitative tightening could help the problem
The long end of the gilt market has started to wobble, with 30 year bonds edging as high as 5.7% in recent days. Although other long bond markets have seen weakness this week, the UK appears to be particularly hard hit – even worse than the French market, where the Government is on the brink of collapse over its debt crisis.
The gilt weakness isn’t universal, with shorter-dated yields giving a more mixed picture. The 10 year gilt has been edging higher since the beginning of August, moving from around 4.5% to their current level of 4.8%. However, 2 year gilt yields remain below 4%.
While this has prompted plenty of hand-wringing about the Chancellor’s judgement, the problem is not necessarily hers to control. Oliver Faizallah, head of fixed income research at Charles Stanley, part of Raymond James Wealth Management, says: "The UK has seen longer dated bonds sell-off a little more than other developed market countries because we've seen a large drop in the longer dated bond buyer base. Historically, defined benefit pension funds were a massive buyer of long end gilts, but as we have seen a shift to defined contribution schemes, demand has dropped. This is a technical issue that has exacerbated concerns around UK inflation and interest rates, combined with global issues.”
While the spike in yields has inflamed speculation about possible tax rises in the budget, it is possible that the problem could be addressed by an easing of quantitative tightening by the Bank of England, Faizallah says. A shift of debt issuance from the long end to the short end by the DMO/UK Treasury would also help.
That said, there is no doubt that clearer plans on cutting spending, tax increases and continued commitment to the fiscal rules at the Budget, would also see some of this sell-off reverse. The summer news pages have been filled with speculation over likely tax rises in the budget. So far, we have seen NI on rental income, changes to the rules on gifting, potential attacks on the banking and gambling sectors, among other areas. The problem with this kite-flying is that it has managed to irritate significant chunks of population, stymy investment, while offering few solutions to the intractable problem of the UK’s fiscal black hole.
The movement of key Treasury personnel into the Prime Minister’s Office shows that Sir Keir Starmer is taking the issue seriously. With the UK’s international position relatively secure for the time being, it may be that a renewed focus on domestic issues could find a way through some of the intractable problems facing the UK economy.
