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Since this thread has been bumped, it's maybe worth noting that today's auction of 1.875% Index-Linked 2022 saw a negative real yield of -0.065% at the strike price.

This is the first time that I've ever seen a negative yield in a gilts auction.]

Presumably that would imply that out to 2022 inflation expectations are high and anticipated interest rates are low.

What benchmarks are used to calculate "real yield"?

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Since this thread has been bumped, it's maybe worth noting that today's auction of 1.875% Index-Linked 2022 saw a negative real yield of -0.065% at the strike price.

This is the first time that I've ever seen a negative yield in a gilts auction.

I was going to say maybe they're anticipating higher inflation, then I noticed you said a negative real yield. Normal gilts are yielding less than predicted inflation, so I guess this shouldn't be such a surprise, but actually seeing it happen is something else.

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Presumably that would imply that out to 2022 inflation expectations are high and anticipated interest rates are low.

What benchmarks are used to calculate "real yield"?

So the purchaser is saying, in real terms they'll get back less than they paid, but this is still better than the current alternatives?

.... does that suggest the markets are truly broken?

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So the purchaser is saying, in real terms they'll get back less than they paid, but this is still better than the current alternatives?

.... does that suggest the markets are truly broken?

Well, there's an argument that says that real interest rates will be reflective of economic growth rates. Consequently if you think the economy is going to contract over a number of years in real terms, then accepting a zero or slightly negative real yield may not be a bad option.

There may be other reasons though - preservation of capital is arguably the most obvious. Also, if you're like some academics who believe that RPI overstates inflation and CPI is a more accurate measure, then the real yield on this linker may not actually be negative in reality (but personally I don't buy this).

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Well, there's an argument that says that real interest rates will be reflective of economic growth rates. Consequently if you think the economy is going to contract over a number of years in real terms, then accepting a zero or slightly negative real yield may not be a bad option.

There may be other reasons though - preservation of capital is arguably the most obvious. Also, if you're like some academics who believe that RPI overstates inflation and CPI is a more accurate measure, then the real yield on this linker may not actually be negative in reality (but personally I don't buy this).

FT, how exactly is the "real yield" calculated? What assumptions/benchmarks are used? Thanks.

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Presumably that would imply that out to 2022 inflation expectations are high and anticipated interest rates are low.

What benchmarks are used to calculate "real yield"?

This is a 3-month lagged IL stock. No inflation assumption is used in the yield calcs on these (unlike the old 8-month lagged linkers).

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The IL gilt is auctioned and bought at 121.90 for a nominal 100.00 worth.

Whoever draws up that table then states that the "real yield" is -0.065% pa.

How is that yield calculated?

The gilt pays 1.875% above inflation on a nominal holding. Ignoring inflation, for the 11 years the gilt has until maturity the 100 will gain 1.875% a year

value after each year

1 101.875

2 103.7851563

3 105.6953125

4 107.6054688

5 109.515625

6 111.4257813

7 113.3359375

8 115.2460938

9 117.15625

10 119.0664063

11 120.9765625

so (unless I'm wrong which I probably am) you pay 121.9 now to get somewhere in the region of 120.97 back in 11 years (plus whatever inflation is). yield % = 120.97/(120.97-121.9), then divide by 11, this gives -0.084% The difference maybe because it doesn't run for exactly 11 years?

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How is it manipulated especially if it was tendered by auction? FT's table shows the AAP was 121.90, what's the DMO supposed to do, say no pay me less?

Is the BoE still buying up Gilts? Just to maintain the £200bn, as surely some of the £200bn must have matured? This would be a manipulation over subscription?

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The IL gilt is auctioned and bought at 121.90 for a nominal 100.00 worth.

Whoever draws up that table then states that the "real yield" is -0.065% pa.

How is that yield calculated?

I'm not 100% sure but I'll have a try. If this was a conventional bond the nominal yield is easy to calculate with a standard yield to maturity because all the variables are known. With an inflation linked bond it's more complicated as the redemption value at maturity is unknown as it is indexed to an unknown value of inflation at maturity. So the only way I can think of calculating a "real yield" is that you have to make an assumption of inflation over the period of the bond.

One 'benchmark' they may use are market expectations of future inflation rates - a proxy for this is the 'breakeven' rate, the difference between the yield on a conventional gilt and that of an index linked gilt for same maturity. They could take the average implied inflation rate for the maturity which they then plug into their 3 month lagged RPI methodology over the life of the bond to arrive at the final redemption value so you can get the yield.

As I said, just a guess, maybe FT can shed some more light.

edit: tried applying YTM calc to the other index linked bonds in the list and assumed a par of 100 and get the same results as the table so think that answers Spaniards question!

Edited by moneyscam
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Is the BoE still buying up Gilts? Just to maintain the £200bn, as surely some of the £200bn must have matured? This would be a manipulation over subscription?

Possible, but then it's mere speculation unless you can prove BOE had a rollover of around 1.07B on that auction date and then outbid all the other buyers who went home empty handed. Or it could just be plain old fashioned scared institutions wanting to park their money anywhere at any price.

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The IL gilt is auctioned and bought at 121.90 for a nominal 100.00 worth.

Whoever draws up that table then states that the "real yield" is -0.065% pa.

How is that yield calculated?

With a conventional bond you get a known future stream of coupon payments and a known sum at redemption, but you don't know what real return you will get. The whole idea of an indexed-linked bond is to give an investor a known real return irrespective of the inflation rate. Therefore on a theoretical basis no assumption regarding future inflation need be made, and the yield calculations can be made in exactly the same way as a conventional bond.

The reason why future inflation assumptions are required for index-linked gilts is because there is an unavoidable lag in the indexing. This used to be 8 months and a number of existing issues are still indexed under these rules. In a high inflation scenario this relatively long lag could significantly affect the real redemption yield (especially with a short-dated gilt), so it's certainly a consideration. However, starting in 2005 (I think) the indexing lag was changed to 3 months, and this made the future inflation issue somewhat moot. The DMO now ignores it, and the real yields published in the Financial Times for 3-month laggers are made without any inflation assumption.

So, the 121.90 price in the auction is the real clean price (i.e. inflation is stripped out). The actual price paid for the stock will be the clean real price uplifted by an index ratio of 1.14365 to give the inflation-adjusted clean price. The real yield calculation is made without reference to an inflation figure. It's simply not needed and the gilt is effectively being treated as a conventional one.

Remember that there's always some sort of uncertainty with redemption yields, even on conventionals - the rate at which future dividends will be reinvested is not usually known.

Edit: spelling / added 4 words for clarity

Edited by FreeTrader
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  • 1 month later...

For the record, the Bank of England's Monetary Policy Committee today voted to increase the size of its asset purchase programme (aka Quantitative Easing) by £75 billion, taking the total up to £275 billion.

The Bank will be purchasing £75bn of UK gilts under the same eligibility criteria as before. The Bank will normally conduct three auctions a week: gilts with a residual maturity of 3-10 years will be purchased on Mondays; of over 25 years on Tuesdays; and of 10-25 years on Wednesdays.

The size of the auctions will be £1.7bn each.

The MPC expects the announced programme of asset purchases to take four months to complete.

http://www.bankofengland.co.uk/markets/marketnotice111006.pdf

Edit: missed word

Edited by FreeTrader
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  • 4 weeks later...

Time to bring this thread back to life ....

FT.com

This week the Bank of England had a narrow escape in the UK government bond markets. By the tiniest margin, it avoided the first auction failure since it started buying gilts in March 2009 as part of its quantitative easing programme, arguably the central bank’s last throw of the dice as it tries to revive the flagging UK economy.

The Bank only managed to cover Tuesday’s auction of over 25-year gilts by 1.06 times. Below 1.0 is considered a failure or uncovered: it means there are fewer bids to sell than the amount the Bank wanted to buy.

..

RBC Capital Markets estimates the Bank needs to take a further £11.9bn out of the over 25-year sector before the end of 2011 and there is about £90bn available before the Bank would own 70 per cent of the free float, its self-imposed limit. In the 10 to 25-year sector the Bank will also be taking a further £11.9bn between now and Christmas and there is an available £63bn before the Bank’s holdings would represent 70 per cent of the free float.

But even before the Bank reaches its ceiling, this week’s lacklustre auction points to potential problems sooner rather than later, particularly given that it is buying more gilts than the UK Debt Management Office is selling by a ratio of £5bn to £3bn a week.

Oh dear, looks like the wheels are coming off ...

Edited by Sour Mash
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How exactly do the BoE QE ‘auctions’ work?

I presume that they are conducted as what is commonly known as ‘reverse auctions’ – a certain amount of money is offered, the QE money in this case, and bidders competitively submit their assets, gilts in this case, in exchange for the fixed amount of money.

The BoE then chooses, all else equal, the largest value of gilts offered.

So it would seem at first sight that the cover of not much above 1.0 indicates only that the bidders are collectively savvy about the auction and that no-one is bothering to submit overly optimistic (i.e. small) offers of gilts for the QE money.

So, does the BoE set a maximum price that they are willing to pay per nominal amount of any particular gilt?

Otherwise I don’t see why the cover should ever drop below 1.0.

PS If not and the BoE really is stuck for gilt sellers then they can have my modest holding for the full £75bn. Job done. :)

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Well, we've got away with it so far but maybe a 'British debt crisis' will hit us in the new year?

Who to turn to?

It always tickles me when I see pundits on the telly going on about the Eurozone debt crisis as if somehow, magically, the UK was absolutely financially sound.

Yeah - the authorities are buying up their own debt faster than they can issue it and even then Gilt auctions come near as a whisker to failing. Nothing to worry about here!

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It always tickles me when I see pundits on the telly going on about the Eurozone debt crisis as if somehow, magically, the UK was absolutely financially sound.

Yeah - the authorities are buying up their own debt faster than they can issue it and even then Gilt auctions come near as a whisker to failing. Nothing to worry about here!

This is a REVERSE auction. Its hardly a failure if you cannot BUY (not SELL) what you are targeting by QE. As the 2062 IL auction showed last week, the DMO has no problem selling as much UK debt as they want (or need) to. All it shows is that they are going to have to move down the credit curve a bit.

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It always tickles me when I see pundits on the telly going on about the Eurozone debt crisis as if somehow, magically, the UK was absolutely financially sound.

Yeah - the authorities are buying up their own debt faster than they can issue it and even then Gilt auctions come near as a whisker to failing. Nothing to worry about here!

Yeah, it's a bit like when Hugh Hendry said 'I'd recommend you to panic' (in relation to the Greek debt crisis) We'll wake up one morning and find we have an unexpected problem, in the meantime eat, drink and be merry.

Btw, Sour Mash, thanks for posting a couple of days ago.

Edited by council dweller
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Could someone please post the full FT article (without breaking any copyright)? I have used up my monthly quota. Thanks.

So, holders are hanging on to their gilts more tightly than the BoE would like.

Surely this indicates market appetite for gilts and downward pressure on sterling interest rates?

Should we not worry more when the DMO auctions have low cover?

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  • 433 Brexit, House prices and Summer 2020

    1. 1. Including the effects Brexit, where do you think average UK house prices will be relative to now in June 2020?


      • down 5% +
      • down 2.5%
      • Even
      • up 2.5%
      • up 5%



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