U.K. Bond Market Has Early Christmas With BOE Reinvestments

  • Coupon payments, maturing gilts also support market: SocGen
  • Gilts returned 1.1% in past month, outperforming Treasuries

The U.K. government bond market may be well-supported this month as an influx of cash is met by a seasonal dearth in liquidity.

Societe Generale SA said Christmas has come early for the gilt market as 10.5 billion pounds ($15.8 billion) of bonds mature Monday, with a coupon of 8 percent. The Bank of England started reinvesting its 6.3 billion-pound holdings of the debt on Monday, and will continue the process over the next week and a half. U.K. bonds also gained with euro-area peers and U.S. Treasuries as oil prices fell below $40 a barrel, damping the outlook for inflation.

“Cash-flow and duration demand should be particularly supportive given thin market conditions,” said Jason Simpson, a strategist at SocGen in London. “There may also be a sense that December is merely the first of two phases, with a repeat set of demand characteristics due to unfold in January,” which include more coupon payments and reinvestments by the BOE of holdings accrued through quantitative easing, he wrote in a note.

Rebalancing of indexes will see their average durations lengthen this month, SocGen’s Simpson said. This will require investors who use them as a benchmark to buy longer-dated bonds to match the change.

Simpson recommends betting on a flatter yield curve, with longer-dated yields falling faster than those with shorter maturities. Traders should target the yield spread between the 2 percent 2025 gilt and 3.25 percent 2044 gilt narrowing to 60 basis points, from about 68 basis points on Monday.

QE Program

The BOE is continuing to reinvest the holdings from its QE program that began in March 2009 when policy makers cut the benchmark interest rate to 0.5 percent, to try and protect the British economy amid the global credit crisis. The purchases are intended to keep the total amount of gilt holdings at 375 billion pounds. Officials have ruled out any unwinding until the key rate has risen materially.

U.K. 10-year yields fell 10 basis points, or 0.1 percentage point, to 1.82 percent as of 4:29 p.m. London time. The 2 percent gilt maturing in September 2025 rose 0.92, or 9.20 pounds per 1,000-pound face amount to 101.615.

The outperformance of gilts may have already taken place, according to BNP Paribas SA. In the past month gilts have returned 1.1 percent, compared with a euro-area average of 0.3 percent loss and 0.1 percent loss in U.S. Treasuries, according to Bloomberg World Bond Indexes.

“Net conventional gilt supply is negative for the rest of the year and barely positive in the first quarter given coupons and BOE APF reinvestment,” said Shahid Ladha, a strategist at BNP in London. “Normally this is supportive of gilts. But the move seems to have happened. We are bearish on gilts. They look rich on a cross-market basis.”

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