The Debt Management Office's Gilts Sales Matter More Than The Spring Budget. The Debt Management Office's Gilts Sales Matter More Than The Spring Budget. The Debt Management Office's Gilts Sales Matter More Than The Spring Budget.

The Debt Management Office's Gilts Sales Matter More Than The Spring Budget.

Bonds
Althea Spinozzi

Head of Fixed Income Strategy

Summary:

- Higher volumes of Gilt issuance coupled with active Quantitative Tightening will apply pressure on Gilts. However, if inflation falls below 2% in the second quarter of the year, as per consensus, there is scope for BOE to deliver more than two interest cuts expected by markets today.

- Gilts up to three years are appealing as they offer a win-win solution to investors. For example, assuming a holding period of six months, 2-year Gilts yields will need to move above 5.8% before providing a negative return.

- Longer duration gilts remain an excellent diversification tool if a hard landing materializes. However, in the case of soft landing, it's safe to expect 10-year Gilts to trade rangebound around between 3.95% and 4.26% until the macroeconomic backdrop is clear.

Analysis:

Yesterday, the Chancellor of the Exchequer Jeremy Hunt delivered modest tax cuts while pushing tax hikes in other areas to offset the costs associated with the cuts, leaving the economic backdrop broadly unchanged from the Autumn Budget.

At the same time, the Office for Budget Responsibility (OBR) released new economic projections for the UK. These projections showed a reacceleration in growth, with the UK GDP rising to 0.8% this year and 1.9% next year. This is a clear rebound from the last forecasts, which showed 0.7% and 1.4%, respectively. The UK budget and OBR projections failed to add a notable bearish sentiment in Gilts.

More relevant for bondholders was the Debt Management Office’s announcement ahead of the UK budget showing a 9% increase in Gilts sales, from £258 billion to £265 billion the next fiscal year. Long-dated gilts are expected to make up less than a fifth (£35.5 billion) of the total Gilt issuance amount, adding pressure on Gilts with tenors of up to 20 years. Indeed, markets are already contending with the Bank of England's plans to reduce its balance sheet.  

As per the market notice published by the BOE on December 15th, throughout the first quarter of the year,  £8 billion of Gilts will be actively sold, 76% of which are short—and medium-term bonds. Gilts maturing before 2040 make up two-thirds of the BOE's holdings.

Since the beginning of the year, medium-term and long-dated gilt yields have been rising steadily despite a significant slowdown in inflation. Ten-year Gilts have underperformed US and German peers as yields rose by 50bps versus 30bp in Germany and 22bps in the US.

Short-term vs Long-term Gilts: risks and opportunities.

Consensus expects inflation to drop below 2% by the year's second quarter to rebound slightly above 2% until the third quarter of 2025. If such forecasts are confirmed, the Bank of England will see scope to begin cutting rates before summer and to deliver multiple rate cuts before the end of the year, surpassing current market expectations of two rate cuts by the end of 2024. Thus, the yield curve will bull-steepen aggressively, with 2-year yields likely to fall below 4%. In such a scenario, the ten-year gilt yield might adjust slightly lower, but as data shows signs of a soft landing, yields are likely to remain supported. Ten-year yields will likely remain rangebound between 3.95% and 4.26% until the economic backdrop is clear. In the case of a soft landing, improving economic activity might see 10-year yields normalizing around current levels; however, if a hard landing scenario forms, 10-year yields are likely to drop below 4%

Yet, the risk that investors will run is that if the disinflation pace is slower than expected, yields might rise again. Thus, while there is scope to increase one’s portfolio duration, we favor short-term Gilts up to 3 years, as the longer the maturity, the more the directional bet on aggressive BOE cuts.

Risk and reward scenario.

Assuming a six-month holding period:

  • 2-year Gilts at 4.3% (GB00BL68HJ26): yields need to move above 5.8% before providing a negative return. While it is true that if inflation proved to be sticky, the BOE might pivot and high rates again, it looks now improbable it will engage in a new tightening cycle, hiking five more times.
  • 3-year Gilts at 4% (GB00BDRHNP05): If yields move up by 100bps to 5%, the loss in one portfolio would be -1.3%
  • 10-year Gilts at 4.1% (US91282CJZ59): if yields increase by 50bps to 4.6%, investors will start to record a loss of -3.5%. However, if yields by the same amount, they will gain +12%.
  • 30-year Gilts at 4-4% (GB00BPSNBB36): if yields move up by 50bps, the loss would be -11%, but if yields move down by the same amount. The gain would be +21%.
Source: Bloomberg.

Quarterly Outlook 2024 Q3

Sandcastle economics

01 / 05

  • Macro: Sandcastle economics

    Invest wisely in Q3 2024: Discover SaxoStrats' insights on navigating a stable yet fragile global economy.

    Read article
  • Bonds: What to do until inflation stabilises

    Discover strategies for managing bonds as US and European yields remain rangebound due to uncertain inflation and evolving monetary policies.

    Read article
  • Equities: Are we blowing bubbles again

    Explore key trends and opportunities in European equities and electrification theme as market dynamics echo 2021's rally.

    Read article
  • FX: Risk-on currencies to surge against havens

    Explore the outlook for USD, AUD, NZD, and EM carry trades as risk-on currencies are set to outperform in Q3 2024.

    Read article
  • Commodities: Energy and grains in focus as metals pause

    Energy and grains to shine as metals pause. Discover key trends and market drivers for commodities in Q3 2024.

    Read article

Disclaimer

The Saxo Bank Group entities each provide execution-only service and access to Analysis permitting a person to view and/or use content available on or via the website. This content is not intended to and does not change or expand on the execution-only service. Such access and use are at all times subject to (i) The Terms of Use; (ii) Full Disclaimer; (iii) The Risk Warning; (iv) the Rules of Engagement and (v) Notices applying to Saxo News & Research and/or its content in addition (where relevant) to the terms governing the use of hyperlinks on the website of a member of the Saxo Bank Group by which access to Saxo News & Research is gained. Such content is therefore provided as no more than information. In particular no advice is intended to be provided or to be relied on as provided nor endorsed by any Saxo Bank Group entity; nor is it to be construed as solicitation or an incentive provided to subscribe for or sell or purchase any financial instrument. All trading or investments you make must be pursuant to your own unprompted and informed self-directed decision. As such no Saxo Bank Group entity will have or be liable for any losses that you may sustain as a result of any investment decision made in reliance on information which is available on Saxo News & Research or as a result of the use of the Saxo News & Research. Orders given and trades effected are deemed intended to be given or effected for the account of the customer with the Saxo Bank Group entity operating in the jurisdiction in which the customer resides and/or with whom the customer opened and maintains his/her trading account. Saxo News & Research does not contain (and should not be construed as containing) financial, investment, tax or trading advice or advice of any sort offered, recommended or endorsed by Saxo Bank Group and should not be construed as a record of our trading prices, or as an offer, incentive or solicitation for the subscription, sale or purchase in any financial instrument. To the extent that any content is construed as investment research, you must note and accept that the content was not intended to and has not been prepared in accordance with legal requirements designed to promote the independence of investment research and as such, would be considered as a marketing communication under relevant laws.

Please read our disclaimers:
- Notification on Non-Independent Investment Research (https://www.home.saxo/legal/niird/notification)
- Full disclaimer (https://www.home.saxo/en-gb/legal/disclaimer/saxo-disclaimer)

Saxo
40 Bank Street, 26th floor
E14 5DA
London
United Kingdom

Contact Saxo

Select region

United Kingdom
United Kingdom

Trade Responsibly
All trading carries risk. To help you understand the risks involved we have put together a series of Key Information Documents (KIDs) highlighting the risks and rewards related to each product. Read more
Additional Key Information Documents are available in our trading platform.

Saxo is a registered Trading Name of Saxo Capital Markets UK Ltd (‘Saxo’). Saxo is authorised and regulated by the Financial Conduct Authority, Firm Reference Number 551422. Registered address: 26th Floor, 40 Bank Street, Canary Wharf, London E14 5DA. Company number 7413871. Registered in England & Wales.

This website, including the information and materials contained in it, are not directed at, or intended for distribution to or use by, any person or entity who is a citizen or resident of or located in the United States, Belgium or any other jurisdiction where such distribution, publication, availability or use would be contrary to applicable law or regulation.

It is important that you understand that with investments, your capital is at risk. Past performance is not a guide to future performance. It is your responsibility to ensure that you make an informed decision about whether or not to invest with us. If you are still unsure if investing is right for you, please seek independent advice. Saxo assumes no liability for any loss sustained from trading in accordance with a recommendation.

Apple, iPad and iPhone are trademarks of Apple Inc., registered in the U.S. and other countries. App Store is a service mark of Apple Inc. Android is a trademark of Google Inc.

©   since 1992