In the middle of this sudden call to action for the UK Debt Management Office, GlobalCapital hosted a panel discussion about the Gilt market, featuring Sir Robert Stheeman, CEO of the UK DMO, an investment banker and some prominent investors. All panellists were aligned in their astonishment at what has happened since early March — especially the meteoric rise in Gilt issuance — but were also in agreement that, so far at least, the system has coped very well: the UK remains well funded, despite the sudden and pressing need for a lot more issuance in a very short space of time.
Panellists also noted that all this extra borrowing has had to be done at a time when key market players have been split up from their colleagues and working remotely from each other, often at home on makeshift desks above the garage or in a spare room. Again, though, the system has held together remarkably — so well that the DMO issued its largest ever bond, a £12bn 10 year that amassed £82bn of orders, in this period.
However, the Gilt specialists were at pains to point out that, as robust as the market has proved to be, the Bank of England’s enlarged quantitative easing programme has played a crucial role in keeping a tight lid on borrowing costs — and even pushed some yields negative. The Bank is expected to further increase this programme in June and might even cut interest rates into negative territory.
As a result, while QE is going on at this pace, few believe the Gilt market will show signs of strain. The true test is going to come as the economy starts to heal and the Bank pulls back from its current pace of buying. Only then will we discover whether the market can really absorb the vastly inflated supply of Gilts.
Participants in the panel were:
David Katimbo-Mugwanya, fixed interest fund manager, EdenTree Investment Management
David Parkinson, sterling rates product manager, RBC Capital Markets
Sir Robert Stheeman, chief executive officer, UK Debt Management Office
Miles Tym, fund manager, M&G Investments
Ian Williams, chairman and chief executive officer, Charteris Treasury Portfolio Managers
Moderator: Toby Fildes, managing editor, GlobalCapital
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GlobalCapital: I think it’s true to say that we’ve never known anything like this. But, Sir Robert, just to kick us off, how does this compare to anything you’ve worked through or in before?
Sir Robert Stheeman, UK Debt Management Office: I can’t really compare it to anything in my entire career. If you had told me at the end of February that we would find ourselves in this situation physically, literally, remotely, today — but also, I suppose, fiscally, financially and with a borrowing requirement that looks very different from what we were envisaging ahead of the March Budget — I would have said maybe it’s time to sit down and relax and let the moment pass.
It’s not like anything that I can recall. But at the same time, it all seems to be working somehow, more or less — and probably more rather than less. That in itself is quite incredible.
David Parkinson, RBC Capital Markets: Robert is absolutely right on all those points. We’ve not seen anything quite like this.
I guess the one thing about the global financial crisis, which was the last time we saw an explosion of issuance, was that it gathered pace. I was looking at the numbers earlier. In April 2008, we were expecting £80bn of issuance in Gilts. By October, that was £110bn, by November £146bn; and then the following year it was £220bn. The one thing that taught me is that when things change, expect them to change some more.
This is on a different scale. A figure of £225bn is what Robert and his team are raising in four months. When things started to change once the lockdown hit us and once you started to see Chancellor Rishi Sunak’s measures being announced, you knew that you needed to be adaptable. You knew that you couldn’t predict what was going to happen next month. And I think one of the things that the market has done very well is adapt very quickly in all sorts of ways.
Miles Tym, M&G Investments: One has to marvel at the sheer scale of what we are seeing in terms of both issuance and the Bank of England’s QE programme — both with an order of magnitude roughly three times of what we saw as we went into the first round of QE and the financial crisis in 2008.
Also, it’s really incredible how the market has adapted to cope in terms of liquidity conditions. I mean, certainly in March, there were some really quite stressed liquidity conditions just before the QE programmes came in and suddenly everyone was scattered all across the country trying to deal remotely. But in more recent weeks we have settled down. In some of the big days in the Gilt market, there are five Gilt events within a few hours and they are all pretty much passing pretty smoothly.
As an investor, we are finding that liquidity in the market is really quite impressive. So I think the market has adapted very well to the new world. I mean, there are going to be some transition periods, I’m sure, over the coming 12 months, when there will be some bouts of volatility and probably disruption. But for the time being, the adaptation that all market participants have shown has been quite remarkable.
David Katimbo-Mugwanya, EdenTree Investment Management: Yes, it’s certainly surprising from my end. Coming into the year, we looked at fiscal expansion as maybe one of the outside risks in terms of the context of stimulus while heading into a potential Brexit-induced recession.
To see things first of all take off that quickly, you’re not alone in being surprised about how fast it happened and then also the scale of what’s taken place. I think working well, for now that is, is a very good outcome. It’s more the questions that come thereafter that we are starting to sort of ponder over at the moment. But I would agree that it’s a very unique situation.
Ian Williams, Charteris Treasury Portfolio Managers: The scale is completely unprecedented. It would be very interesting to see further down the road how much this astronomical amount of quantitative easing results in higher inflation. That’s the big unknown at the moment. This is not a get out of jail for free card. There’s a cost with it.
GlobalCapital: Sir Robert, everyone has mentioned the vast increase in numbers that we’re now seeing before us. Maybe you could go into a little bit more detail and tell us about the expansion of the DMO’s funding programme and how you have changed your strategy to meet these new requirements?
Stheeman, UK DMO: So, as recently as just over two months ago, at the time of the Budget, the envisaged Gilt programme for the year was about £156bn — and that was genuinely what people were expecting.
The Budget took place on March 11. Literally within days, the whole situation changed. The lockdown came into place 10 days later. Some of the illiquidity in the markets that others have referred to became much more pronounced in the following days — interestingly, not because of what was going on in the UK necessarily, but actually what was happening in the US and the pressures in the Treasury market, too, at that time.
So, then it became clear to the government that more cash would be needed.
We were initially asked to raise £45bn specifically in the month of April. But don’t forget £156bn was for the whole financial year, from April 1 until the end of March 2021. So that was revised within a fortnight of publication. No more detail was available at that point.
There was then the remit revision on April 23, which usually occurs at this time of the year, reflecting the CGNCR outturn for the previous year. The Treasury combined that with their estimated financing requirement for May through to the end of July, and that was an extra £180bn. So within a period of effectively six weeks, a full year’s £156bn had turned into a four months’ requirement of £225bn.
At this stage we are not being explicit about what will be required for the rest of the year. Quite understandably, and this is true for any government in the world at the moment, the Treasury faces significant uncertainty in terms of its annual financing needs and it would be futile to put out something that just gets changed again.
So, the next development in terms of the actual remit and what we have to do will come at the end of June, when we will be announcing what we intend to do in the following quarter, the period from July through to September.
The precise skew of issuance that results will depend on the decisions that ministers make and our decsions about which bonds to issue in what sizes using which particular distribution methods. We think that that is a sensible, pragmatic approach. We will have to see how it goes but so far it has actually worked remarkably well.
GlobalCapital: Everything seems to have gone quite well. But I’m just wondering, have there been any signs of strain from investors absorbing the extra supply?
Williams, Charteris: No, I don’t think you’re going to get a strain because there’s a lot of cash and a huge amount of liquidity sloshing around — and the Bank of England potentially monetising some of the budget deficit anyway. I think the strain might be on the investors who are watching the equity market go up every day and wondering why they are into Gilts on negative yields. But that’s a different story.
Tym, M&G: As Ian says, there’s no strain at the moment because of the sheer scale of the quantitative easing. I mean, they’re sort of pretty much matching pound for pound what the UK DMO is issuing —and actually, in terms of duration, probably even marginally outstripping that. So while the QE is going on at this pace, I don’t think you are going to see the strain. The true test is going to come as the economic conditions become not quite as dire and the economy starts to heal and the Bank of England pulls back to some degree from the current pace of QE buying. That’s when you are going to see a true test of the market’s ability to absorb the issuance and the extra debt because at the moment the Bank of England is providing a huge backstop there.
Parkinson, RBC: We’re finding that the auctions are going well and the syndications are going well. As the others have said, there’s plenty of liquidity around, helped by the Bank of England.
Robert and his team don’t know what the issuance is going to be for the full year, but I imagine we’ll end up in a situation where the funding for the full year has been frontloaded. At the same time, the Bank of England’s actions are coming thick and fast early in the process, when the economy needs the help the most. So those two things match up quite well and things are working.
There have been some good innovations along the way. The DMO has introduced larger post-auction options. The original auction target for April was £45bn but the DMO actually ended up raising £55bn. There have also been other innovations like the first ever 10 year syndication, where the DMO was able to raise £12bn in one go. Those kind of approaches are certainly helping the process of getting the cash in that the government needs so urgently.
Katimbo-Mugwanya, EdenTree: I definitely see the market digesting it quite well thus far. At some point, either the Bank of England will need to step up the amount that it purchases or the private markets will need to step up the amount that they purchase. I think that will be an interesting juncture.
I also think there are concerns — not just in the UK, but around the world. Everyone, of course, is fiscally expanding. There is QE taking place; however, the free float of government debt is going up, a change in the sort of trend observed in the past few years.
I’d like to think that there will be more of a concession in terms of Gilt yields and the cost of funding. Of course, it really helps the government to fund in these conditions, when rates are at all-time lows and I can understand the attractions from the perspective of safe haven demand. But let’s not forget, however, that even with yields this low, you’re not really ruling out inflation over the long term. So when the market then turns around and starts pricing in some of these risks, I think that will be an interesting point.
GlobalCapital: Sir Robert, we are painting a fairly smooth operational picture here. But in the individual debt sales, are you having to pay more or less than you have been in the past to attract a broader universe of investors? And indeed, is that universe of investors wider than it has been?
Stheeman, UK DMO: The first part of the question is easier to answer than the second part, in as much as I would say that the current yield levels are without a shadow of a doubt at — or very, very close to —historical lows. So clearly, these are very low funding levels. But in terms of what that actually means for the future, who knows what rates might do? Who knows what happens further down the road? QE can always be unwound. I have no idea when — that’s obviously one for the Bank and for the MPC. But I wouldn’t just assume that this is a one-way street for ever.
In terms of the investor base, your second question, I think it’s harder to say. With the 10 year syndication that we held just a couple of weeks ago, we had sight of a book in the way that we would not necessarily have sight of the exact bidding behind a 10 year auction.
My sense is that you’re not necessarily looking at a significant increase or expansion of the investor base, but we have much greater visibility of this, partly thanks to the syndication process.
GlobalCapital: To the investors, what do you make of the DMO’s approach since March and is the mix of auctions and syndications the most appropriate method?
Tym, M&G: I think it’s going very well, so far. The fact that we have all been referring to the general sort of smoothness of the process would suggest that the balance is about right, and I think it is.
The combination works well with the regular supply because you’ve got the regular buy-backs. If you were only going to do big blocks of supply, but with regular buy-backs, you could run into real pockets of squeeze, etc. So the regular small events are working well.
But at the same time, I do think the first two syndications have also gone very well. The DMO is taking what I think is exactly the right approach, which is that you might be paying a very small concession – I mean, one or two basis points — but the flipside of that is you’re getting a very big, solid, well-received book, you’re instantly creating a brand-new issue that’s straight on the map and you’re funding at what are overall very, very low levels in terms of yield. I think that’s exactly the right thing to do, so you’re ensuring that as you create some very big blocks of new bonds, they’re getting very smoothly digested. So I think the combination of the regular auctions and the large syndications is working very well.
Williams, Charteris: The DMO is a superbly professional operation. I was in the Gilt market when Denis Healey was running a 20% budget deficit of GDP and they were trying to finance it through tax and it was chaotic — so this is chalk and cheese to how they used to do it.
Parkinson, RBC Capital Markets: Things are going remarkably well. I don’t think the DMO is really paying meaningful concessions. As Miles says, it’s a basis point or two, here and there, but the quid pro quo is large size and getting ahead of what’s already a very ambitious funding target. The proof of the pudding is in the eating.
We were a bookrunner on the 10 year and there were names that we hadn’t seen in a syndication book before — but not necessarily names that are new to the Gilt market. I think one of the successes of the syndication programme since it was introduced a decade or so ago is that it has probably brought the DMO and the investor base a bit closer together — and replicating that across a wider investor universe can only be a good thing.
GlobalCapital: Is it too early to see where demand patterns are changing? Are investors favouring particular tenors or formats?
Parkinson, RBC Capital Markets: I don’t think there has been a massive change in terms of tenors. I think one thing that has jumped out to me in the last two months or so is that investors are using this spike in supply to update their portfolios with more current coupon bonds. It’s one of the pieces of feedback we keep hearing from people. The DMO has chosen to do a lot of new issues. Six new lines are being launched in the space of two and a half months, which in itself is quite unusual. But certainly, as far as I’ve heard, investor feedback is quite favourable towards that. People are very keen — as long as the terms are reasonably attractive or fair — to update their portfolios and buy the new coupon bonds that are available.
GlobalCapital: Might we, though, be potentially approaching a sticky point in late June when the pace of issuance will outstrip the Bank of England’s asset purchase facility. Is that something on people’s radars?
Parkinson, RBC Capital Markets: Our view is that there will be another £200bn of QE announced by the Bank of England in June. I think one of the big strengths of the Gilt market is its ability to adapt. The investor base is extremely professional and extremely nimble when it needs to be. At some point, as David Katimbo-Mugwanya says, the pace of issuance and the pace of buy-backs from the Bank of England will be out of kilter. We don’t know which way around that will be. But to my mind, that just means that there will be a change in the price and then the market will carry on with business as usual.
Stheeman, UK DMO: I can understand why some people may think: “Aha, so, the end of June is going to be an interesting period. What happens then?”
And I completely understand that. For what it’s worth, I think it’s probably a good point for me to emphasise that we have to borrow regardless of what the Bank of England may or may not decide to do. The programme and the way we have tried to design it has not been developed with one eye on those nice people down at Threadneedle Street. It has been designed primaily to make sure that the cash the Treasury needs comes in the door when it is required.
So I will watch with as much interest and curiosity as anyone else what the Bank may or may not decide to do as the weeks unfold. But in all of this, the Bank is always the second mover. We have to decide what we issue and the Bank will make its decisions on the basis of what it believes is the appropriate monetary stance at that given time in order for it to achieve its monetary policy objectives. Of course, there must be some linkage there because developments in the Gilt market can affect monetary conditions. And that is, I think, why you have seen them act in the way they have. But I think that sequencing is also important.
GlobalCapital: So, the possibility of the Bank of England pushing rates into negative territory has of course been mooted. How would this affect demand for Gilts and your strategy of bringing them to market?
Stheeman, UK DMO: I think you have to accept that while a negative yield on a bond may not be attractive to one investor for whatever reason, it might well be attractive to another investor. Otherwise, yields wouldn’t be where they are in the first place and I think it is important to understand that. Negative yields are, as yields are in any case, not just a question of the supply or demand, but also reflect expectations around monetary policy developments. Whether those expectations prove to be correct is a completely different matter. We ultimately recognise that, from where we sit, we have to pay the market price. And we would have to pay the market price if yields were negative, positive, or much higher. If we have to issue, we will pay the market price.
Tym, M&G: When you’re talking about the pricing of long-term Gilts, whether UK base rates are currently plus or minus 10bp or 15bp shouldn’t really make a huge difference to the pricing of them. And indeed, in isolation, it probably doesn’t. What is of far more significance is the surrounding economic factors, the outlook for the economy and monetary policy and other monetary measures as well as just base rates.
If conditions were such that the Bank of England deemed negative base rates to be necessary, you would imagine the surrounding economic circumstances would be looking pretty poor and the demand for safe haven assets such as Gilts would be high, probably at the expense of other assets.
So you would imagine that, all else being equal, a negative rates environment is reasonably supportive for Gilt pricing, albeit possibly only marginally the further out the curve you go. The prospects of negative base rates is far more significant for the pricing of shorter dated Gilts than it is for longer dated Gilts, which is totally theoretically correct and not surprising at all.
Williams, Charteris: It doesn’t really matter if the Gilt market is living with negative yields up to sort of six, seven year bottoms at the moment. You’ve had negative real yields on index-linked Gilts for the past seven years. But it does matter for the banking system. If the Bank of England went negative, it would have profound implications for bank profitability, bank lending and all sorts of stuff.
I think they will look at what happened in Europe with negative bank rates and decide that the downside on the banking system isn’t worth it. As [former Bank of England governor] Mervyn King said at the end of May, cutting rates by 25bp isn’t going to make people rush out and take holidays. It doesn’t make any difference to the consumer whether rates are zero or minus 25bp. But it does matter to the banking system. And I think the potential damage to the banking system isn’t a price worth paying.
Parkinson, RBC: I guess there are the two parts to the question: whether negative rates will happen and whether it will affect Gilt demand. But as Ian said, we have had negative yields on index-linked Gilts for a long time. At the long end, actually, we have also had long dated forwards in the Sonia swap markets at negative rates for some weeks now, on and off. I think the market will continue to function. I think if rates are cut into negative territory as an appropriate response to the economic situation at the time, the demand would be there.
GlobalCapital: Is there a risk that the additional Gilt supply will crowd out private sector issuers looking to access capital markets?
Katimbo-Mugwanya, EdenTree: There could be a case, if you have Gilt free float going up and private investors are having to participate to a greater extent in Gilt auctions, that this could crowd out private issuance. I would highlight recent comments from the Bank of England showing a preference for equity funding rather than debt funding, as well. So, in that context, if you have private issuers stepping back, while of course the government is issuing more, there’s every chance that with sterling, especially given that its volumes are not as big as in euro or dollar debt issuance markets, you could have this phenomenon taking place. I think that is a genuine risk going forward.
Tym, M&G: At some point there’s got to be some kind of debt level generally across the economy where you certainly get to a danger of debt funding crowding out equity funding. In terms of the immediate term, I would certainly not see this as too much of a risk for non-government issuers being crowded out of the market. Across products that we manage, there’s very strong demand for fixed income non-government flows in a broad range of assets. At the moment, there is just an awful lot of liquidity and an awful lot of interest to buy fixed cashflows.
Stheeman, UK DMO: I recall back in 2008 when our borrowing requirement suddenly started to increase that this sort of question came up a lot then. I think perhaps behind that question is a slight misconception about two things.
First, that would potentially be the case if there were what I would describe as a finite amount of liquidity and we alone were the big heavy issuer going in and draining that finite amount of liquidity ourselves and not letting the smaller guys have a look in. But actually, because liquidity is so good, you’re not talking about a finite amount of liquidity. And one of the intentions of the Bank and central banks around the world is to ensure that liquidity is in ample supply at a time like this. So that’s the first point.
The second thing I would note is that a well‑functioning, liquid and relatively large government bond market usually acts as the catalyst for corporate issuance and you can see that nowhere better than in the US. And in both instances, the liquidity of the underlying government market can act as a benchmark. But it’s utility as a pricing point for corporates should not be underestimated, either.
GlobalCapital: Another question for the investors, the government’s action is going to have a big impact on your roles as buyers and sellers of UK government bonds. I’m just wondering where you stand today. Do you applaud what the government has done to step in and help the economy or do you disagree because it has had a negative impact on your holdings?
Katimbo-Mugwanya, EdenTree: That’s a very interesting question. It needed to act quite quickly, given the speed of the lockdown measures taken. That said, over the long term, I would be more cautious, given the deluge of supply that’s heading our way. It’s not necessarily about whether the government is right or wrong. Of more immediate concern is whether we are correctly positioning for the sort of outcomes likely to result from those actions. Our view is definitely that Gilts are more risky than they were before the latest fiscal policy changes and so looking at them as a safe haven asset is going to get a bit more difficult.
Williams, Charteris: Well, the Bank of England isn’t buying Gilts to bail out the Gilt market. It’s buying Gilts to bail out the economy and as a mechanism to inject liquidity into the system.
QE is the big determinant of why yields are where they are today. If we didn’t have QE, you wouldn’t have yields where they are today and you wouldn’t have the FTSE at 6,100 and you wouldn’t have gold at an all-time high. So it doesn’t just affect the Gilt market. This has follow-through effects in all the markets. At some stage, if Gilt issuance carries on and QE tapers off, then the yield will go steeper.
Tym, M&G: It may be that my clients’ portfolios suffer at some point down the line but they are pension funds or long duration assets. So they certainly haven’t suffered so far in terms of total return if you look at where they are priced now compared with where they were a few months ago.
Do we support the response? Yes, in terms of the immediate fiscal and monetary response to the lockdown, I don’t really think there was much choice. I think the government had taken the decision to lock down the economy, which they knew was going to have dire consequences, and therefore made some very strong fiscal and monetary responses to offset that.
The concern is more, I guess: what are you letting out of the box further down the road? The danger is that you are getting an electorate hooked on very large fiscal handouts. I think that’s a big danger. Rishi Sunak has played a strong hand so far and has done very well. But he’s going to be a damn sight less popular when it comes to autumn and he’s got to start rolling back on some of the fiscal measures that he has implemented.
GlobalCapital: Would you like to see the UK Municipal Bonds Authority being used more? Currently local authorities make heavy use of the Public Works Loan Board, which is ultimately funded by the DMO. If more of them were to access the market via the MBA, it might reduce some pressure on DMO funding. On the other hand, it would increase the overall cost to the public purse. Where do you stand on this?
Parkinson, RBC: Our expectation is that there will be more issuance and we would be broadly supportive of that. From the point of view of the wider discussion we’ve been having about the Gilt market, though, the sort of numbers I hear suggest that MBA issuance will be in the high single billions to low double digit billions against a DMO remit which will probably end up at £300bn-£400bn for this fiscal year. It’s a relatively small amount, so it’s not going to have a great deal of impact either way on the overall cost of public sector funding.
Tym, M&G: It’s not something that has been enormously on our radar screen, not least because when you consider the size of the existing Gilt market and the size of the existing investment grade and corporate bond market, it’s on a much smaller scale at this point in time.
Obviously, it might become a significant part of the investment landscape at some point in the future, but at the moment, it’s not very high on our radar screen.
GlobalCapital: I’d like to return to something mentioned at the very beginning, which was how we have all got used to operating in different circumstances very quickly. So what have been the operational challenges of working from home? How has it been?
Stheeman, UK DMO: I think the biggest challenge has been the lack of proximity to each other in terms of being able to communicate as well as one can when one is in a single location together.
The technology has worked very well actually. I recently had a conversation with some of my debt management peers in other countries and we were saying this has gone much better than any of us would have thought.
We have a very small core team in the office. On days when we are holding operations, I usually tend to be there in the office.
The simple things such as broadband internet have allowed us to function in a way that would have been very difficult, I think, in the financial crisis 11/12 years ago, and literally unthinkable 20 years ago. It’s almost a cause of celebration. It has inevitably meant that we have had to reconsider our internal processes, compliance rules, all sorts of things.
It has gone remarkably smoothly. And the fact that everyone comments on how good liquidity is in the market is a sign that obviously others must be experiencing the same thing.
Parkinson, RBC: As a salesperson, if you suggested to me six months ago that I could do my job from home I’d have laughed. But when you’re forced to do it, you find that you can and things have worked remarkably well.
We’ve used technology differently. We’ve changed some of our working habits. Some of the compliance processes have had to change or be added to, but things are working. The market remains liquid. There have been a lot of operations to get through and the fact that they’ve all gone smoothly suggests that banks and investors have risen to the challenge. In addition to the technology that’s being deployed, I think it’s a testament to the professionalism and the adaptability of people on both the buy-side and the sell-side
Tym, M&G: Before all this I was actually working from home one day a week, mainly because it was technologically possible. But it wasn’t really possible to execute transactions from home, so I wasn’t doing it very often and I was having to be in contact with my colleagues in the office to get them to put the trades through for me, etc.
Whereas ahead of lockdown we put in place the compliance procedures to allow us all to operate like this. We are all working from home now. We have to very much salute the job that our IT department has done in terms of providing support for us all to make this transition. It has been quite remarkable really. When we come out of this. I’m not going to be working in the office four days out of five. I think I’ll be working in the office one or two days a week and working from home three to four days a week.
I do think it’s necessary and desirable to still have some face-to-face contact with your colleagues and my slight concerns about the way we are operating right now is not the day-to-day running of the portfolios, but the broader point about being in touch with your colleagues in other areas of the business and staying in touch with the whole set-up. So, for that reason, I certainly wouldn’t want to be based permanently at home for ever, but certainly I am going to be doing a lot more up in my room above the garage, and a lot less in the office.
GlobalCapital: Sir Robert, is the awarding of big mandates going to change, given the remote way we are all working now?
Stheeman, UK DMO: I think for the very first syndication, which we did 15 years ago in September 2005, we had not just the metaphorical but the literal beauty parade! But ever since we started the syndication programme in earnest back in 2009, I don’t think there have been any further in-person pitches.
Indeed, we actually run a rather strict sort of regime, really, in order to be fair to everybody. We ask those interested parties to make their pitches in a specific slot of 15 or 20 minutes. But that all happens by telephone. We do obviously receive written material which complements what we hear on the phone and that gives us a pretty good view of the market.
