The United Kingdom is once more staring down the barrel of multiple market shocks, as the recent run of dramatic events best described as 'everything, everywhere, all at once' continues at pace. But, the UK Debt Management Office is poised to navigate the storm without too much consternation, yet again.
For starters, this month's ONS figures revealed that core inflation in May is higher still than it was in April, when it fell less than had been expected. Before that had even happened, yields on two-year UK Gilts rose last week to within touching distance of the panic levels that followed the Truss-Kwarteng mini budget in September 2022.
Then, the Bank of England delivered a surprise 50bp rate hike last Friday, 25bp higher than expected, and markets have since begun pricing in a terminal rate closer to 6% than the 4.75% bulls had hoped for back in the spring.
It appears that despite the volatility, the DMO has little to worry about when it comes to pricing new deals, particularly if its syndications year-to-date are anything to go by. Indeed, the UK DMO’s primary dealer network told GlobalCapital that the combined shocks would be water off a duck's back for the debt agency as it looks to its next sovereign syndication in July.
On Tuesday, June 27, the UK announced that the deal — its third from a syndicated issuance plan this year of £27bn — will be a re-opening of a 2045 index-linked Gilt, hardly the move of an issuer lacking confidence.
So far, the UK has raised £9.8bn in this fiscal year from syndicated issues, which have all attracted order books of above £40bn. It has two syndications planned for the second quarter — the first in the week commencing 10 July 2023 and another in the first half of September.
At this point no self-respecting investors should be surprised about the persistence of UK inflation, which is in part a consequence of Brexit-related labour shortages, and should instead embrace the market volatility for what it is. Despite the market volatility, bankers claim, the UK’s Debt Management Office is usually able to get deals done with considerable success and should be trusted as such.
if you go step by step, with confidence, you can go far
On the second day of Euromoney’s 2023 Global Borrowers conference this year, the same day that May’s inflation print was published, DMO chief executive Robert Stheeman reaffirmed this confidence to delegates. “The fixed income world today, and in particular core government bond markets, are deeply liquid and have the ability to reprice,” he said, and the confidence is due.
While Stheeman would not comment on the Bank of England’s monetary policy specifically, he highlighted that the central bank had done well to intervene during the autumn mini-budget crisis: “The underlying fundamentals of the sterling market meant it was ripe for a correction when a correction was due.”
When Liz Truss’ unfunded tax cuts sparked generational highs in Gilt yields last year, triggering calls to post collateral for leveraged LDI funds, the DMO re-opened a 0.125% March 2073 index-linked Gilt, which it still managed to price at the tight end of guidance, securing an 11 times oversubscription. The crucial point, Stheeman added, was that the UK’s core investor base “didn’t change fundamentally at all and there is still regular demand from international investors”.
Though high UK inflation has persisted — even as it has started to fall in the rest of Europe, and even more so in the US — the DMO has still executed strong syndicated transactions, even as the Bank of England has embarked on a quantitative tightening programme that will see it reduce its government bond holdings by £80bn by November.
When core CPI rose again to 6.8% in April, up from 6.2% in March and well above the bank’s expectations, and Gilt yields rose towards their mini budget highs, reaching 4.37%, the DMO brought a new 2063 line to the market, drumming up orders of £54bn. Investors flocked to the long sterling bonds even as it became clear the bank will need to raise rates for a while yet and perhaps keep them higher for longer. After May’s print, the market began pricing in terminal rates of 6.5%.
This is impacting the primary markets. While demand for Gilts has not wavered, there's been a drastic reduction in sterling bond issuance this year from other SSAs, as borrowers favour other currencies boasting richer demand and better pricing.
The DMO has shown resillience and is right to be confident in its own ability as an issuer. No doubt its upcoming linker tap will be as successful as the rest of its transactions this year, that is not the worry.
The real concern is that just about every other part of the sterling bond market that could be in trouble for the foreseeable future.