Hammond Can Win the Gilt Market
There's no Hammond premium, as far as the gilt market is concerned.
True, prices have been plummeting precipitously lately. There's a global bond rout afoot because inflation's on the horizon, while Brexit stress has already done some damage.
Chancellor of the Exchequer Philip Hammond, who will present his spending and debt plans in Parliament on Wednesday, is of course in a prime position to worsen the picture -- the Autumn Statement is an opportunity for this new post-Brexit government to announce its giveaways.
Gilt investors will probably come away happy as "Spreadsheet Phil" looks like he'll live up to his reputation for avoiding fireworks. That doesn't mean the market will give him a free ride.
Perennial demand from pension funds and defined benefit pension plans means more supply can easily come through without disrupting things too much. An increase of 5 billion pounds ($6.2 billion) to 8 billion pounds in extra issuance in the next fiscal year from the current period's planned gross 129.4 billion pounds is already largely priced in.
But what else lies in wait? There has been much talk of increased infrastructure spend post Brexit.
Hammond seems to be signalling to debt investors that he's not going to go crazy on a vast infrastructure buildout. He spent the weekend touring the TV studios peppering soundbites on the government's "eye-wateringly large debt" and "significant deficit." In this context, a billion pounds here on broadband improvements and a billion pounds there on road repairs would be fairly small beer.
UBS forecasts about 15 billion pounds extra in gilt issuance whereas HSBC sees about 25 billion pounds more, and these estimates include further outlays for infrastructure spending. In the final analysis, if the Chancellor is clear in his methodology and does not pull any surprise rabbits out of his hat, he could probably get away with anything in that range without forcing a big leg down in prices. That whole slug would trickle through over a few years, and so wouldn't have to represent a large burden of excess supply.
It is important he keeps the government bond market his friend, so if he does want to go for a big infrastructure blowout, or even if he wants to be extra careful about managing even just a bit more spending, he has some options.
The government could pressure public sector pension funds to take some of the heavy lifting on funding by cajoling and enticing them into buying bonds in quasi government-backed entities. Maybe such old-fashioned ideas as railway bonds might reappear.
Or there could be something more new-fangled, such as creating special-purpose vehicles and shifting much of the future burden off the government's balance sheet. Such infrastructure bonds could then be eligible for the Bank of England's corporate bond purchase program, creating a virtuous circle.
He'll also have an easier time if he weights issuance toward the longer end, which is where client demand is. However, up to now the Debt Management Office has been pretty consistent in looking to spread issuance evenly across the curve. This makes the chances of a 100 year bond unlikely for now -- but the market lives in hope.
Gilt investors will also look beyond these and focus on the structure of his forward projections. They'll want to know particularly when, if ever, Hammond expects to be able to balance the books. His predecessor's target to erase the budget deficit by 2020 will be extended by at least two fiscal years. Any major spending rise that extends further out than this might spook both the bond and currency markets.
Bear in mind the Bank of England is still happily buying back another 60 billion sterling of gilts across the yield curve. Not too much danger with extra issuance if your central bank is buying it back.
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