The Gilts Thread

[FreeTrader]

This has been a very eventful week in bond markets, and I think it's true to say that Wednesday's late action in U.S. Treasuries emphasised to all and sundry that the global issuance of sovereign debt at levels which are unprecedented outside wartime is THE story of the moment. The article that Mike Livingstone posted a few comments above gives a very good overview of the situation and it's a must-read for anyone who's a late arrival to this thread.

The chart below shows the yield on the 10-year Treasury over the past few days, and as you can see we had an impressive pull-back over Thursday and Friday from the high of almost 3.75%. Many traders however remain unconvinced of the longevity of this retracement because it was made on low volume and there was also believed to be some month-end buying of Treasuries as trading desks squared off their positions. It seems likely therefore that underlying pressure for yields to rise will persist as long as the U.S. Treasury is feeding this enormous amount of new debt into the market.

Thus far the Federal Reserve has been playing down the significance of the rise in Treasury yields, basically arguing that the curve-steepening we're seeing is a natural consequence of economic recovery. A number of analysts (Tim Bond of Barclays Capital for example) agree. However I don't think anyone really believes that Fed staff are quite as sanguine as they appear, and if these yields continue to push up then the betting is that there will be some sort of policy reaction – perhaps some additional QE. It's going to be an interesting summer.

Meanwhile in the U.K. gilts market, yields are continuing their gradual rise and this is despite the Bank of England buying £6.5 billion of gilts each week, considerably more than the Debt Management Office is currently selling at auction. We've got approximately 9 weeks left of QE buying from the BoE, and if they don't extend the programme then the gilts market will finally be on its own and the DMO will have to shift all that debt without a large offsetting buyer in the secondary market. As the potential ending of QE approaches, we're liable to see the absence of the BoE being priced into yields, so that's something to be aware of.

Here's the chart for the current 10-year gilt, the 4.5% Treasury 2019, and it shows the yield is creeping up despite the BoE's intervention. It's now above the 3.63% close of 4 March, the day before the initial £75bn QE programme was announced. Is this due to investor concern over public borrowing and money printing, or is it simply a natural consequence of better economic prospects? Again, I think we're going to get a much better idea over the coming summer.

You don't need to look at the bond market if you want to see signals that Chairman Bernanke might be about to put the presses into overdrive.

The dollar index closed the week at 79.23, and is now flirting with its December low:

Oil continues to rise:

And finally, gold is knocking on the door of $1000 again:

We can all hear the rotor blades starting up, but are the bond vigilante commando team going to sabotage the take-off?

Edit: added missed word, deleted another.

Edited May 30, 2009 by FreeTrader

[lufc]

posted by BHP Tinto on gei. This is a must read. This is a very, very serious situation.

THE HORROR, Bond traders are white with terror

What's happening in bond land? The latest US govt bond auction was for $110 billion. Two years ago the average monthly bond auction total was $5 billion, $10 billion, numbers like that. The US govt finances its debt with bonds. A $2 trillion deficit means $2 trillion in new bonds needs to be issued. Approx. $200 billion a month.

That's one scary read GOM.

As this financial f@ckup has gradually unravelled and all of the potential "solutions" have been touted, even with my limited financial/economic knowledge I've often thought to myself "thats simply not possible - it can only make the situation worse", but low and behold a couple of months down the line plan X is executed.

Seems to me that at the moment the overall "market" is proving that it can't be bucked - western debt simply can't just be monetised without paying a very, very heavy price and the market knows it.

[moonriver]

If this was on the main news though the masses wouldn't have a clue anyway.

Yes, despite the fact there is a lot I still need to learn, and am trying to do so, I find the fact that most of the public, have no clue at all, a rather scary thought, in the current economic climate.

And I appreciate, as MikeLivingstone points out, that this is the most important topic currently on hpc.

My thanks again to all the informative posters here, who are carrying on informing and educating me, and others.

[shedfish]

some of the insight on this thread and Mike's is awesome. i've been chopping bits out and printing off to read here and there... it occurs to me that some of this is worthy of publication, some kind of paper / QE diary

this pdf is the bit on 'Why QE' from the other day. as a rough guide it stands up well

YQE.pdf

i hope FT doesn't mind... i'll take it down if so

YQE.pdf

[winkie]

all these bond issuances....one has to ask...where is the money coming from??

as GOMs post says, the QE isnt enough to cover what the US are about to issue...by a long shot....and the UK will be competing for the SAME MONEY.

QE will not work all it is doing is stalling the inevitable.

[Guest Daddy Bear]

QE will not work all it is doing is stalling the inevitable.

I reckon I got out of cash just in time.

I really cannot understand how people cannot see what is coming?

http://www.housepricecrash.co.uk/forum/ind...p;#entry1903492

[shedfish]

I reckon I got out of cash just in time.

I really cannot understand how people cannot see what is coming?

http://www.housepricecrash.co.uk/forum/ind...p;#entry1903492

what, such as a bounceback in Sterling and an uptick in interest rates, coupled with the continued slow collapse of the property market?

only joking... fair play

[leveller]

I was planning on giving up booze until this thread came along.

[grumpy-old-man-returns]

I was planning on giving up booze until this thread came along.

education is great isn't it ?

I love learning, the problem is the more you know, the more you need to know.

[endgame]

Bond vigilantes set for rebellion against the West's wasteful ways

Liam halligans latest article on the bond market.

http://www.telegraph.co.uk/finance/comment...teful-ways.html

[leveller]

education is great isn't it ?

I love learning, the problem is the more you know, the more you need to know.

It is great, but so time consuming (time being the problem?).

Like my Fridays plans were mostly forgotten, and instead this thread, it's links, wiki, and a dictionary, took it over.

(thread bump allowed?)

(( Off topic here, sorry, but the reason why I read these threads is to try to put more meat on the skeleton to the thoughts I have on what to do with my cash now and in the future, as I am trying to wake up a bit more.

Is it too little too late for me too learn what to do with my hard earned though?

Being a nervous novice nobody doesn't help.

No-one I know is interested in talking about stuff like gilts and bonds etc, who can blame them when booze and sex is more fun, so thanks to you all for the free educashun here

Sorry I can't give more back to these threads, and even if I could, my tipsy posts would probably nullify any relevance. A problem with my posts is after a certain time when I'm drunk in charge of a computer ))

[Ash4781]

http://www.telegraph.co.uk/finance/comment...he-economy.html

US bond sell-off putting pressure on other parts of the economy The US bond market is trying to tell us something and we should all be listening.  By Mohamed El-Erian

[Sybil13]

I was planning on giving up booze until this thread came along.

Well try not to feel too gilty about it

[leveller]

Well try not to feel too gilty about it

I don't, not enough time, too many other emotions elsewhere Sybo

[Sybil13]

Gilts Lose Allure

June 1 (Bloomberg) -- U.K. debt is losing its allure for the biggest owners of gilts as the nation’s worst recession since World War II batters the government’s finances, according to a Bloomberg survey.

Eight of 10 funds, which oversee a combined $2.9 trillion, said they are either more likely to sell than buy British government bonds in the next three months or have no plans to purchase them, the survey conducted last week showed. Two said they were more inclined to buy than sell the securities.

Prime Minister Gordon Brown’s government aims to sell a record 220 billion pounds ($355 billion) of debt in the fiscal year through March 2010 to finance bank bailouts and measures designed to drag Europe’s second-largest economy out of the recession. Standard & Poor’s cut the outlook on Britain’s AAA credit rating to “negative†from “stable†on May 21, citing the country’s growing debt burden.

The U.K. is “spending heavily to rescue the banking system,†said Yuuki Sakurai, general manager of finance and investment planning in Tokyo at Fukoku Mutual Life Insurance Co., which oversees $54 billion. “The rating should be lowered.†Fukoku, one of the money managers surveyed, has no plans to buy gilts this year, he said.

British government bonds lost 3 percent this year, according to Merrill Lynch & Co.’s U.K. Gilts Index. That compares with a 1.3 percent loss from German debt and a 4.3 percent drop from U.S. securities, Merrill’s German Federal Governments and U.S. Treasury Master indexes show.

Schroder ‘Near Zero’

Reduced demand and rising debt issuance from governments around the world may force the U.K. to offer investors higher returns to hold gilts. Germany’s borrowing costs on 10-year bonds rose to the highest this year at an auction on May 20. Declines in gilts drove the yield on the benchmark 10-year security 26 basis points higher to 3.76 percent in May.

London-based Schroder Investment Management Ltd. said last week it cut gilts in its global fund to “near zero,†citing the probability of a credit downgrade.

“The U.K. clearly has a structural problem as it is spending more than it can justify,†said David Scammell, a London-based money manager at Schroder. “The fiscal outlook just doesn’t work.â€

Britain’s Debt Management Office couldn’t find enough buyers at a sale of gilts on March 25, the first so-called failed auction since 2002. The debt agency, which normally relies on scheduled auctions to raise money, plans to enlist help from banks to sell 25 billion pounds of debt in eight syndications this fiscal year.

Downgrade Expectations

S&P said that Britain’s debt may rise to 100 percent of gross domestic product, a level that would be “incompatible with a AAA rating.†Managers of seven of the funds polled expect Britain to lose the rating, the Bloomberg survey showed.

The U.K. would become the fifth western European Union nation to have its credit grade lowered this year, following Ireland, Greece, Portugal and Spain. The debt burden next year will be 66.9 percent of GDP, exceeding Canada’s 29.1 percent and Germany’s 58.1 percent, according to April 22 forecasts by the International Monetary Fund.

New York-based BlackRock Inc. and Tokyo-based Kokusai Asset Management Co., among the top 10 holders of U.K. debt that make regulatory filings, according to data compiled by Bloomberg, said they are buying gilts maturing in 10 years or less.

“We are long gilts,†said Scott Thiel, the London-based head of European fixed-income at BlackRock. “If yields increase substantially, we’d certainly be a much better buyer of the gilt market.†A long position is a bet that an asset price will rise.

Kokusai’s Holdings

The $47.3 billion Kokusai Global Sovereign Open Fund increased its holdings of U.K. bonds to 6.2 percent of assets, from 4 percent at the start of 2009, according to Masataka Horii, a senior money manager in Tokyo at the fund.

The funds that participated in the survey were Axa Investment Managers, BlackRock, F&C Asset Management Plc, Fukoku, Insight Investment Management, Kokusai, Mizuho Asset Management, Pioneer Investment Management Ltd., Samsung Investment Trust Management, and Schroder.

Foreign investors held 216.4 billion pounds, or 34 percent, of total gilts outstanding at the end of last year, according to the Debt Management Office.

To contact the reporter on this story: Anchalee Worrachate in London [email protected]

Last Updated: June 1, 2009 01:54 EDT

[FreeTrader]

After a subdued start today, the gilts market is falling this afternoon. The yield on the 10-year gilt is currently 3.83%, up 8 basis points on the day.

Meanwhile in the US, the 10-year Treasury note opened down, pulled back some of the loss, but has since fallen quite heavily. The yield (which moves in the opposite direction to price) is 15 basis points up on the day at 3.61%.

Remember that last week the US 10-year hit the headlines when the yield surged to 3.75% on Thursday, before recovering impressively to finish the week at 3.46%.

[FreeTrader]

The BoE has just announced the results of today's £3.5bn reverse auction of gilts under QE. The cover ratio was a low 1.58, which is a bullish sign (the opposite of the DMO's auctions) and the market has immediately pulled back some of today's losses.

[Panda]

http://www.reuters.com/article/wtUSInvesti...E54U1NZ20090531

The way i read it is, sooner rather than later, base rates will start nudging up? Thoughts Freetrader?

[Timm]

Sorry to butt in, but I need to clarify this.

I think I understand the situation here up to the point that prices have fallen to the point that increased yields impact on market rates to the extent that they threaten any recovery / make it expensive for governmentd to finance their expenditure. (Please correct me if I am wrong up to this point).

Where I know I am confused is what this would mean. I would have thought it would simply mean a very serious recession. But the Hyperinflationists seem to think it would result in more bonds being bought through QE by central banks. But by that point, wouldn't this just exaggerate the problem? I mean to my uneducated eye, it would look like all pretense had been dropped and the CBs were de facto funding Gov deficit. So why would they do it? Does there not come a point where they have to run up the white flag and take their punishment rather than keep fighting to the last bullet?

[FreeTrader]

http://www.reuters.com/article/wtUSInvesti...E54U1NZ20090531

The way i read it is, sooner rather than later, base rates will start nudging up? Thoughts Freetrader?

I wouldn't really like to say, but that Reuters article is fairly typical of a number that came out over the weekend where Fed officials 'who wished to remain anonymous' were briefing journalists and saying that their objective under QE was not to cap yields.

None of it sounded particularly convincing.

My guesstimate (and that's all it is) would be that govt bond rates are going to ratchet up saw-tooth style. In other words we'll see a progressive rise as the weight of issuance weighs heavily on the market, but there will be some sharp pull-backs along the way. However that doesn't mean base rates will necessarily go up in tandem. That's very much in the hands of the central banks still.

[FreeTrader]

Sorry to butt in, but I need to clarify this.

I think I understand the situation here up to the point that prices have fallen to the point that increased yields impact on market rates to the extent that they threaten any recovery / make it expensive for governmentd to finance their expenditure. (Please correct me if I am wrong up to this point).

Where I know I am confused is what this would mean. I would have thought it would simply mean a very serious recession. But the Hyperinflationists seem to think it would result in more bonds being bought through QE by central banks. But by that point, wouldn't this just exaggerate the problem? I mean to my uneducated eye, it would look like all pretense had been dropped and the CBs were de facto funding Gov deficit. So why would they do it? Does there not come a point where they have to run up the white flag and take their punishment rather than keep fighting to the last bullet?

Timm, your thinking is correct. You've articulated the problem that faces both the BoE and the Fed if medium and long-term bond rates continue to rise.

My argument has always been (even before QE started) that if they persisted with QE in the face of buyers walking away, then they could end up as the only buyer in the market. More QE will simply cause yields to be driven higher. Yet there are many analysts that are still out there urging both central banks to step up their purchases (mind you, I think these analysts have a vested interest).

It's a giant game of chicken with the UK and US economies at stake. I don't think we're close yet to what they term a 'dislocation' where the market goes into freefall, but no one knows where that tipping point may be. I think this is the reason why the Fed has been cautious in intimating whether QE will be increased, especially with Geithner in China at the mo'.

[FreeTrader]

Just to add to the above, this was always my argument against the goldbugs when they were arguing that hyperinflation was an inevitability. I've always respected the inflationist case because we all know that democratic governments who have a relatively short-term election cycle can't easily stop spending money, and this time the weight of debt (both public and domestic) is unprecedented.

Resorting to inflation to reduce the real value of that debt is the obvious answer. But that assumes that your creditors are going to simply roll over and die. Well no, they won't, not while you still need to borrow more from them. If they sniff that you're clipping the coins they'll exact a price. That price is higher interest rates.

[the_duke_of_hazzard]

Just to add to the above, this was always my argument against the goldbugs when they were arguing that hyperinflation was an inevitability. I've always respected the inflationist case because we all know that democratic governments who have a relatively short-term election cycle can't easily stop spending money, and this time the weight of debt (both public and domestic) is unprecedented.

Resorting to inflation to reduce the real value of that debt is the obvious answer. But that assumes that your creditors are going to simply roll over and die. Well no, they won't, not while you still need to borrow more from them. If they sniff that you're clipping the coins they'll exact a price. That price is higher interest rates.

So what was different about Weimar Germany that allowed hyperinflation to happen?

[FreeTrader]

So what was different about Weimar Germany that allowed hyperinflation to happen?

In the end I imagine it was political will, as it is with any regime that decides to debase its currency in order to inflate away debt.

I'm not familiar enough with the build-up to Weimar's hyperinflation (I'm talking about the step-by-step monetary policies in the months and years prior to the hyperinflation itself). However, one of the aspects of today compared to 1923 must surely be transparency. The QE programmes of both the Fed and the BoE are published, as are purchases in the open market under those programmes. We have markets that are tradable at the touch of a button and we also have the Internet with hundreds of sites like this one monitoring every move that the respective central banks make.

This increased transparency allows creditors and traders to pre-empt any mass monetisation attempt, which should act as a safety valve (and I'd argue that we're seeing the mild rumblings of this now). The effects will eventually manifest themselves in currency markets, and it's my belief (but by all means call me naïve) that the BoE and the Fed would raise interest rates if a fall in the currency became precipitous. It might plunge the country into years of severe recession because of the debt overhang, but it would surely be better than the alternative.

[the_duke_of_hazzard]

In the end I imagine it was political will, as it is with any regime that decides to debase its currency in order to inflate away debt.

I'm not familiar enough with the build-up to Weimar's hyperinflation (I'm talking about the step-by-step monetary policies in the months and years prior to the hyperinflation itself). However, one of the aspects of today compared to 1923 must surely be transparency. The QE programmes of both the Fed and the BoE are published, as are purchases in the open market under those programmes. We have markets that are tradable at the touch of a button and we also have the Internet with hundreds of sites like this one monitoring every move that the respective central banks make.

This increased transparency allows creditors and traders to pre-empt any mass monetisation attempt, which should act as a safety valve (and I'd argue that we're seeing the mild rumblings of this now). The effects will eventually manifest themselves in currency markets, and it's my belief (but by all means call me naïve) that the BoE and the Fed would raise interest rates if a fall in the currency became precipitous. It might plunge the country into years of severe recession because of the debt overhang, but it would surely be better than the alternative.

I'm guessing Zimbabwe had neither political will nor transparency in its markets.

I've also been skeptical of hyperinflation arguments for the reasons you more eloquently outline, but the political fallout of needing to tap richer folk for more taxes to bail out the poor sure will be interesting.