U.K. Bonds' Record-Low Auction Yield Masks Stress in Gilt Market

  • Gilts underperform developed-market peers after sale
  • Auction last month saw lowest demand in almost seven years

U.K. government bonds fell even as the nation auctioned debt at a record-low yield, showing that the stresses that saw demand plunge in recent gilt sales are far from over.

The Debt Management Office sold 2.75 billion pounds ($3.9 billion) of debt due in 2026 Wednesday at an average yield of 1.59 percent. While investors bid for 1.52 times the auction target, it was smallest auction of a 10-year security since March 2015.

Gilt auctions have attracted fresh scrutiny since a Jan. 20 sale of 2021 securities resulted in the lowest demand since 2009 amid rising market volatility and yields at multi-year lows. DMO Chief Executive Officer Robert Stheeman reiterated last month that he couldn’t rule out a so-called uncovered auction “at some point.”

“There was a big price concession into the actual auction and while it obviously got away, the prices never actually bounced back and gilts have traded lower since,” said Jason Simpson, a strategist at Societe Generale SA in London. That “tells me it wasn’t a fantastic auction.”

Extending Slide

U.K. 10-year gilts fell for a fourth day on Wednesday, with the yield rising five basis points, or 0.05 percentage point, to 1.49 percent as of 4:25 p.m. London time. The 2 percent security due in September 2025 declined 0.42, or 4.20 pounds per 1,000-pound face amount, to 104.56.

Primary dealers have warned that tighter regulation is reducing their ability to take risk, limiting them from buying bonds at auctions without immediate orders to sell them. SocGen ended its role as a gilt-edged market maker on Feb. 5 after Credit Suisse Group AG announced it was quitting in October.

Gilt investors are also concerned about the economic risks of the U.K. potentially leaving the European Union as Prime Minister David Cameron prepares for negotiations on the terms of Britain’s membership. The talks in Brussels this week are set to determine the timing of the government’s referendum on whether to remain in the bloc.

“The trouble is, it’s not a very clean trade for gilts,” said SocGen’s Simpson. “Do you buy gilts as a safe-haven trade in the case of Brexit, or do you sell them?”

While gilts underperformed their developed-market peers Wednesday, they’ve benefited this year from their reputation as one of the safest assets amid financial-market volatility.

The U.K. is the best performing major bond market tracked by the Bloomberg World Bond Indexes, returning 4.6 percent this year through Tuesday. The MSCI Index of world stocks lost 8 percent including reinvested dividends in the same period, while the Bloomberg Commodity Index dropped more than 4 percent.

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