Britain’s bond market is undergoing “a major repricing”, but should comfortably absorb the extra 62 billion pounds ($69 billion) of debt announced after finance minister Kwasi Kwarteng’s Sept. 23 mini-budget, the head of the UK Debt Management Office (DMO) said on Monday.
Robert Stheeman – the man tasked with overseeing Britain’s 2.1-trillion-pound government bond market – saw a parallel between the high volatility over the past 10 days and that in March 2020 early in the COVID-19 pandemic, when the Bank of England also intervened to calm markets.
But overall the situation in recent days felt different, as bond dealers had generally been better able to keep trading, “albeit in very difficult conditions”, compared with early 2020, Stheeman told Reuters in an interview.
Ten-year British government bonds recorded their biggest calendar-month fall since at least 1957 in September, as concerns about Kwarteng’s unfunded 45 billion pounds of tax cuts added to fears of a sharp rise in interest rates by the Bank of England (BoE) and other major central banks.
Ten-year yields rose to their highest since 2008 on Sept. 28 at 4.582 per cent, up 70 basis points from before Kwarteng’s mini-budget. They were just under 4 per cent on Monday.
“Gilts and other sovereign bond markets are all having to undergo some major repricing,” Stheeman said.
“There are so many uncertainties … in terms of not just the fiscal picture, but the potential monetary policy response. That is what is causing … a very large part of the market volatility,” he added.
The DMO increased its 2022/23 financing target by 72 billion pounds to 234 billion pounds after Kwarteng’s mini-budget, 62 billion pounds of which would be funded by gilts.
“I am confident that it can be digested reasonably smoothly,” Stheeman said.
British government bond prices rallied on Monday after Kwarteng announced a U-turn on one of his flagship measures, saying he would no longer scrap the top rate of tax paid by the highest 1 per cent of earners.
But Stheeman said the market was more focused on the government’s broad fiscal stance, and crucially how that would affect the pace at which the BoE will raise rates.
BoE Chief Economist Huw Pill last week warned the Bank would probably need to make a significant adjustment to interest rates on Nov. 3, when it is next scheduled to make a policy decision. The next day, the BoE stepped in to buy billions of pounds of 20- and 30-year gilts to stem a market slide.
Stheeman – whose wife sits on a BoE committee involved with the decision – said the central bank’s purchase announcement had come as a “major surprise”, in the middle of a DMO operation to sell 4.5 billion pounds of government debt.
While the timing of the announcement may have made life trickier for bond dealers, Stheeman said its unexpected nature did highlight the BoE’s independence.
CLIFF-EDGE FOR GILTS?
The BoE has said it will stop buying bonds on Oct. 14 – long enough, it believes, for pension funds hit by falling bond prices to get their houses in order – and plans to restart its postponed gilt sales programme on Oct. 31.
Asked if he was worried about these potential cliff edges, Stheeman said: “I am not unduly anxious. I think it is in the nature of the market in which we operate, that there is always potential for uncertainty, and that clearly applies now.”
Failed auctions, where the DMO is unable to raise the amount of money it is seeking on a given day, could never be ruled out, he added. The last was in 2009.
Most of the increase in debt issuance over the rest of the financial year will come from short-dated, and to a lesser extent medium-dated, gilts. Stheeman said this reflected greater liquidity in that part of the market.
Wide bid-offer spreads for gilts – which on Monday were around 10 basis points for two-year gilts, according to Tradeweb data – would hopefully narrow as market volatility reduced, Stheeman said.
Regulators also needed to look at how liability-driven investment (LDI) funds in the pension industry used derivatives, he added.