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"The biggest problem with rising gilt yields is simply the increased interest burden on public debt."

Hi FT - this is one of the bits i dont get.

Is not the interest that govt will be paying fixed when the gilt is sold ie the coupon.

How does what it trade for and therefore yield after the intital sale have anything to do with the what govt pay?

cheers

CHF, I hope these short articles can clarify things for you:

http://www.debtbombshell.com/bond-market.htm

http://www.debtbombshell.com/consequences-...tional-debt.htm

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"The biggest problem with rising gilt yields is simply the increased interest burden on public debt."

Hi FT - this is one of the bits i dont get.

Is not the interest that govt will be paying fixed when the gilt is sold ie the coupon.

How does what it trade for and therefore yield after the intital sale have anything to do with the what govt pay?

cheers

Those are very good links thanks.

In response to CHF, my understanding is that yes indeed the government does keep paying the same interest on the face value of existing gilts, once they have been sold. The gilt yields might go up because they start trading at lower prices, but that does not affect the money paid out on each gilt. However if gilt yields do go up, then I assume the government has to increase the interest payments on new issues of gilts in order to make them competitive. That's when the government ends up paying more.

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wasn't it supposed to keep yields low?

Yes, and now that there is a perception QE might be winding up, yields start to rise.

ergo: QE was keeping the lid on rates. To get them down again we need more QE.

Well, that's what you would say if you were a QE fanboy.

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great links

thanks for thsoe.50s Quiff.

nice haircut by the way ;)

Thanks Reapa, I wrote the site myself to help people answer some of these questions.

It looks like it could use some expanding though. If the mods don't mind I might post a feedback thread so I can collect some ideas about how to strengthen the site.

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Because they now cost less to buy, gilt yields start to rise. This means we pay more in interest for every penny we borrow, suffocating our deeply unhealthy economy even further. Everything from trade finance to mortgage payments would get more expensive.

50s quiff - nice site but i still dont get it,

Cos at the minute i just keep thinking if im going to pay you 4%, im going to pay you 4%. Im not interested how much that gilt (and therefore the yield) is worth on the secondary market

unless it is the resultant higher coupon we have to offer on further gilt sales that increases our interest obligation as a whole?

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unless it is the resultant higher coupon we have to offer on further gilt sales that increases our interest obligation as a whole?

I think that's precisely it. It's my understanding that the price on the secondary market has ramifications for credit elsewhere in the economy.

I'm no expert (far from it - just a layman trying to put what I've learned in laymen's terms), and I'd like to hear a full, detailed explanation from a one of the experts on this thread.

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An increasing market gilt yield has two impacts.

On new issuance, the government has to pay the higher market rate.

On issuance already in the market (i.e. sold previously) the government still pays the original rate and the value of the gilts reduces so that someone buying them today get's the same effective rate. This effective rate is a mix of the interest paid by the government and received by the noteholder and the fact that the noteholder would pay, say, 98p in the £ and get back 100p in the £ when the gilt reeems.

Thus, when gilt rates increase, they do not immediately increase the existing cashflow cost of the existing government debt, but it does make the new debt more costly to service.

For the wider market, higher gilt yields can reflect higher long term interest rates, i.e. an expectation of inflation and therefore higher interest rates coming down the track. On the other hand, they could reflect QE if they are lower or a lack of investor appetite / increased risk of counterparty (HMG) if they are higher.

HTH

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"The biggest problem with rising gilt yields is simply the increased interest burden on public debt."

Hi FT - this is one of the bits i dont get.

Is not the interest that govt will be paying fixed when the gilt is sold ie the coupon.

How does what it trade for and therefore yield after the intital sale have anything to do with the what govt pay?

It doesn't, and sorry if my statement confused you.

The interest on a conventional gilt is fixed at the time of auction so market changes won't affect interest costs on gilts already issued. However between now and the end of the 2013/14 fiscal year, the government projects it will have to borrow £700bn to cover its budget deficit, and the DMO will be trying to finance that as cheaply as possible.

Furthermore you have to remember that the DMO is constantly rolling the existing debt as older gilts mature and have to be redeemed. Redemptions this fiscal year total only £16.5bn, but in 2010/11 £39bn will have to be rolled and in 2011/12 £49bn is due. If you add redemptions to the £700bn I spoke of above, the DMO will be looking to sell around £875bn in government debt over the next 5 years.

To put this sum into perspective, here's a chart from the DMO's 2009/10 Debt Management Report that shows the size of the gilts market over the past couple of decades:

giltmarketsize.gif

In short, it's not the interest burden on the existing debt we need to worry about, it's what's coming.

Edit: missed word.

Edited by FreeTrader
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Super duper!

Thats what i thought, its just some of the language used implies direct relation. Yeah its simples now.

as in.......

The first 10billion we sold we offered 4%, but this next 10 billion is gonna have to be at 4.1% to get any takers.

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that's an awful lot.what level of cover would indicate sauration point being at hand?

It would probably be pretty low. The chart below shows the cover over the past couple of years, so I think we'll need to see cover consistently below 1.5 before there's any real concern. It may simply not happen of course – there should always be buyers of gilts at the right price. An uncovered auction isn't the end of the world either, but it may add to the atmosphere of the Government finances being in total disarray.

giltcover.gif

Also,historically what's the widest spread between base rates and say five year gilts there's ever been?Do you know where I could find out.

I haven't got data for the all-time records. Looking at the past 16 years, we're still about 45 basis points below the 3.7% spread seen in 1994 between Bank Rate and the 10-year gilt, but we're a good 100 bps lower on the 5-year. We're not really in jaw-dropping territory yet.

BTW the 10-year yield has recovered to 3.75% after the unexpectedly weak producer price data.

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I think that's precisely it. It's my understanding that the price on the secondary market has ramifications for credit elsewhere in the economy.

I'm no expert (far from it - just a layman trying to put what I've learned in laymen's terms), and I'd like to hear a full, detailed explanation from a one of the experts on this thread.

Every issuer, corporates, governments, worry how their bonds trade in the secondary market as it indicates required yield on new issues (assuming you can issue at all).

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cheers free trader.Can't believe that 10 year/BOE spread isn't near it's record highs.

Does anyone know how much the QE has impacted the gilt market? If the full £125bn of QE has been used to buy Gilts that equates to 25% of total issuance this year. If we exclude the purchases by the BOE cover would be only 1.4 and not 1.8? It seems to me that we are about to hit a wall. Gilts issuance is planned to rise even faster and the largest buyer the BOE has decided not to participate.

The impact of this will be crowding out. As gilts yields rise the banks will stop trying to lend to housebuyers at 5% as they can get 4 or even 5% risk free by buying Gilts.

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I wonder if ratings agencies could have indicated that another batch of QE would mean a downgrade?

Interesting question.

Does anyone have any idea if this could be a reason, or have any other ideas as to why there was no more QE announced last week?

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Interesting question.

Does anyone have any idea if this could be a reason, or have any other ideas as to why there was no more QE announced last week?

might be connected with Obama's recent 'no second stimulus' statement? someone might have had a quiet word about the dollar at the G8, or one of the rating agencies might have been making noises

Edited by ɥsıɟpǝɥs
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might be connected with Obama's recent 'no second stimulus' statement? someone might have had a quiet word about the dollar at the G8, or one of the rating agencies might have been making noises

thanks for your reply.... yes, any of those sound like they could be a reason.

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Interesting question.

Does anyone have any idea if this could be a reason, or have any other ideas as to why there was no more QE announced last week?

Maybe they're giving in to the inevitably of an extended depression - plan A has failed. What will plan B be?

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Thought it might be of interest:

The Bank of England Stop Printing Money- but gilts are still a well

By Associate Editor David Stevenson Jul 10, 2009

The Bank of England shocked the markets yesterday – by doing nothing.

The Monetary Policy Committee's decision to hold the base interest rate at 0.5% was hardly news – nobody had expected that to change.

But the Bank's decision not to extend quantitative easing – i.e. it's not going to print any more money for now – was the big surprise. The fear that the Bank will now stop buying gilts altogether drove yields sharply higher (i.e. prices fell).

So what happens next?

Markets had expected the Bank of England to extend its quantitative easing (QE) programme from the current £125bn to the £150bn ceiling endorsed by the Treasury. Some had even expected it to ask for a higher ceiling. So its decision not to ask for any more money at all was a big surprise.

QE involves buying mainly UK government bonds (gilts) from investors. The idea is that the latter end up with more cash in hand. The Bank hopes this will encourage them to invest in riskier assets, helping to lower borrowing costs throughout the economy, and eventually ending up in the pockets of shoppers and home loan borrowers via more bank lending. It's basically what desperate central bankers do to make money even cheaper when interest rates have fallen as far as they can go.

It's hard to tell if QE is working or not

From the Bank's perspective, the decision to hold off for now is understandable. The central bank doesn't know what sort of impact the scheme will have in the longer term. Recent economic data suggests that for the time being, the economy isn't in freefall any more – and annual CPI inflation is still above the Bank's target rate of 2%. So taking a bit of time out to consider what's going on is a good idea.

The trouble is, it's hard to tell if QE is really working or not. As we pointed out in Money Morning last week (The one retail share worth buying), Britain's banks have dug themselves into such a big hole after making so many bad loans that lending to private individuals is hardly growing at all. Any money raised from gilts they sell to the Bank is sitting in their vaults, while the rest of the Bank's cash has gone abroad, as overseas investors have dumped their own gilt holdings.

But that's the picture today. The trouble is, that may not last. If you increase the amount of money sloshing around the system without creating any new things to buy, you risk stoking up future inflation once the banks do start lending again. That's bad news for government borrowing – if inflation rises, investors will demand higher returns on gilts, forcing up long-term interest rates and killing any economic recovery off before it's barely begun.

The real problem with Britain's economy

But wait a minute – if the Bank has decided to stop printing money, then why did gilt yields jump? Isn't this good news for bond investors?

Well, yes and no – and here's where we come to the crux of the problem – our massive national debt.

The government needs to sell at least £220bn-worth of gilts this year, the biggest fund-raising effort in our national history. That's just to keep the Treasury's books balanced.

As long as the Bank was squatting like a gorilla in the gilts market, with a potentially unlimited supply of money, then investors didn't have to worry too much in the short-term about being able to offload unwanted gilts.

But now, if the Bank is no longer going to be handing out free money, attention turns back to how the government will fund its incredible borrowing requirements. So far the Treasury has got away with it – this week's gilt auction flogged another £4bn-worth – but things are now likely to get a lot tougher.

There's already been some rating agency talk that the UK could lose its top-notch AAA credit rating. That would be very bad for gilts, as fund managers who can only invest in AAA-rated bonds could no longer hold them - and also would have to unload their existing stock.

These key investors will need to see some serious slashing in government spending before they back Britain with their cash. But what we're seeing from No.10 is more the opposite. According to the latest edicts from Gordon Brown, the government's planning to spend even more money it doesn't have.

Net result: even more jitters. Andrew Balls at the world's biggest bond fund PIMCO tells Bloomberg: "we prefer German bunds over gilts"; UK debt suffers from an "unfavourable economic outlook and increased debt supply". "We're concerned about the budget deficit," says Masataka Horii at Tokyo's Kokusai Global Sovereign Open fund.

Gilts are still a sell

These are the guys who hold the purse strings. They don't like QE, because as bond investors, they hate inflation; but they also get worried when the governments they lend to don't seem to care a hoot about running up massive overdrafts. So unlike the Bank of England, they won't buy UK government bonds until they're happy that the yield they're receiving is high enough to compensate them for the extra risks they're taking on.

And on present government policy, that's likely to be much higher than the 3.8% that 10-yr gilts are currently paying. Longer-term, UK government bond yields have a long way to fall unless the money printing press is turned off for good, and public spending is slashed.

As my editor John Stepek says in this week's magazine: "I'll not hold my breath". For now, gilts are still a sell.

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June's UK Public Sector Net Borrowing came in at £13.0bn, somewhat better than forecast, and both April and May's numbers were revised down. However the gilts market just gave a weary shrug.

Cumulative borrowing for the first three months of the current fiscal year is £41.2bn. The full-year budget forecast for 2009/10 is £175bn.

Public sector net debt rose to £798.8bn at end-June (56.6% of GDP). Excluding financial sector interventions, net debt is £657.5bn (46.6% of GDP).

psnb0609.gif

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June's UK Public Sector Net Borrowing came in at £13.0bn, somewhat better than forecast, and both April and May's numbers were revised down. However the gilts market just gave a weary shrug.

Cumulative borrowing for the first three months of the current fiscal year is £41.2bn. The full-year budget forecast for 2009/10 is £175bn.

Public sector net debt rose to £798.8bn at end-June (56.6% of GDP). Excluding financial sector interventions, net debt is £657.5bn (46.6% of GDP).

psnb0609.gif

In future when the figure is lower than forecast it will be because they haven't managed to raise the money at auction, not because they've cut spending.

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In future when the figure is lower than forecast it will be because they haven't managed to raise the money at auction, not because they've cut spending.

I don't follow. Haven't all auctions been successful? And isn't this the borrowing requirement figure (ie what they needed to borrow, not the amount they've actually borrowed?).

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In future when the figure is lower than forecast it will be because they haven't managed to raise the money at auction, not because they've cut spending.

...but no signs of any great stress at present Mike.

The DMO has just posted the result of today's auction of £4bn 4% Treasury 2016. Cover was 1.70 and the tail was 0.8.

Last time this gilt was auctioned (October 2008) the cover was 1.61 and tail also 0.8. So, not a great deal of difference.

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