Bond Vigilantes Get Ready to Test UK Pledge to Balance the Books


Bond investors expect considerable belt-tightening when Rishi Sunak’s government unveils its economic strategy Thursday — and will be poised to sell if pledges to slash spending aren’t met.

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(Bloomberg) — Bond investors expect considerable belt-tightening when Rishi Sunak’s government unveils its economic strategy Thursday — and will be poised to sell if pledges to slash spending aren’t met. 

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The gilt market is already on edge, with confidence fragile after the shock of the Liz Truss administration’s mini-budget in September. The pressure is on the new government to trim what it can to curb borrowing over the coming years and limit a debt deluge that could test investor appetite.

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“The bond markets are expecting austerity,” said Michael Michaelides, a fixed income analyst at Carmignac. “If the government doesn’t deliver a significant amount of consolidation, then you can expect an adverse market reaction.”

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Gilts have recovered ground in recent weeks, with 10-year yields falling around 130 basis points from a high reached in October. Chancellor of the Exchequer Jeremy Hunt is looking to source more than £50 billion ($59 billion) from spending cuts and tax hikes. That would be a complete turnaround from Truss’ plans for unfunded tax cuts, which triggered a tumultuous sell-off in UK assets that saw the Bank of England intervening to stave off a gilt market crash. 

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Supply Risks

The immediate focus in the aftermath of Thursday’s announcement will be adjustments to this fiscal year’s bond supply, according to Citigroup. At the last mini-budget, the government announced that there would be an increase of £62 billion in gilt issuance for this fiscal year from its earlier projections in April. 

“Gilts will likely focus more on any change to this year’s remit rather than the long-term sustainability effort,” wrote Citi strategist Jamie Searle in a note to clients on Friday, anticipating a cut of £9 billion in gilt issuance from September’s projections. “The gilt market remains febrile, and even small news could create oversized reactions.” 

To be sure, confirmation of the government’s tighter fiscal policy could be a green light for initial gains next week, according to Paul Grainger, a portfolio manager at Schroders Plc. “If they continue to stick to their mantra and the economic data continues to weaken, that’s good for the bond market,” he said in an interview. He is overweight UK gilts over European government bonds. 

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Still, some investors warn that any initial rally could soon be challenged by the outlook for the future. The additional issuance to fund packages such as energy cost support initiatives will come at a time when the BOE is unwinding its bond holdings accumulated in buying programs — in sharp contrast to during the pandemic, when it acted as a ready buyer.  

NatWest Markets strategists anticipate that the amount of gilts the private sector and foreign investors will have to absorb translates to £111 billion and £260 billion for this and the next fiscal years respectively — a sharp increase from an average of £35 billion between 2012 to 2021.

“The market should start to focus on that longer-term theme of massive net supply, and people may start scratching their heads and wonder how’s the market going to digest all this?” said Craig Inches, head of rates and cash at Royal London Asset Management.

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This Week 

  • In the UK, the budget and gilt remit update on Thursday will garner investor focus, as well as inflation figures for October
  • The ECB’s announcement Friday will reveal how much TLTRO funds banks will repay early; German ZEW survey numbers will also attract attention
  • There is a large slate of speakers scheduled in the week, including European Central Bank President Christine Lagarde and Bank of England Governor Andrew Bailey
  • Bond sales from Germany, France, Spain, Finland and Greece are set to total about €22 billion ($22.7 billion) according to Commerzbank AG. Italy sells a BTP Italia retail bond. The EU may mandate banks for a bond sale. The UK sells two bonds for a total £5.5 billion.

—With assistance from Sujata Rao, Greg Ritchie and Alice Gledhill.



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