Keith Wade, Chief Economist & Strategist, James Bilson, Economist
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For professional investors and advisers only. This document is not suitable for retail clients.
In a September 2012 Talking Point piece we suggested that the changing dynamics of the world economy would create a fundamental shift in the demand drivers for US treasuries between now and 2017. These include smaller trade surpluses from emerging Asia and a reticence to continue recycling these surpluses into US federal debt.
A significant proportion of the recent net Treasury issuance has been purchased by the Federal Reserve, a price-insensitive buyer. Though the Fed is still purchasing treasuries through quantitative easing, the gradual normalisation of monetary policy will place an increased burden on price-sensitive buyers, such as the domestic private sector, to soak up issuance. Over the medium term, upward pressure on Treasury yields will be required to induce these investors to purchase these assets. In addition, financial repression, such as imposing minimum Treasury holdings in pension portfolios, could become an increasingly appealing method of filling the funding gap.
We investigate the likely dynamics of the UK gilt market over the medium term. Is the funding gap for the UK government larger than in the US? Will gilts suffer from reduced buying by Asian central banks like treasuries? Do UK investors have the willingness and ability to absorb financial repression to the same extent as their transatlantic counterparts?
Our conclusions are:
– HM Treasury has a significant amount of issuance to place in the next five years, as the sizable structural element and weak economy keeps the deficit elevated
– The Bank of England has only recently entered the gilt market, but is already a dominant player. We expect it will continue to buy assets to a total of £450bn, which will help place some of the issuance
– The external sector is likely to continue buying but, with reduced trade surpluses as the world rebalances, the rate of buying is likely to slow
– Domestic banks are unlikely to contribute much due to easing liquidity rules and already improved liquidity positions, increasing the burden on the non-banking domestic private sector
– We see pension and insurance funds contributing about £135bn, more than double than the previous five years, driven by capital requirements and the global shortage of ‘safe’ assets
– It is conceivable, however, that more forceful legislation, such as minimum gilt/asset ratios, is implemented to assist the Treasury in placing its issuance
– A large burden will fall on households and companies. Though there are structural forces pushing them towards increasing gilt holdings, higher yields will be needed to induce them to buy in the long term. Higher yields are also needed if we are to see a funding switch from price-insensitive buyers (the domestic central bank) to other price-sensitive buyers
For professional investors and advisors only. This document is not suitable for retail clients.
This document is intended to be for information purposes only and it is not intended as promotional material in any respect. The material is not intended as an offer or solicitation for the purchase or sale of any financial instrument. The material is not intended to provide, and should not be relied on for, accounting, legal or tax advice, or investment recommendations. Information herein is believed to be reliable but Schroder Property Investment Management Limited (Schroders) does not warrant its completeness or accuracy. No responsibility can be accepted for errors of fact or opinion. This does not exclude or restrict any duty or liability that Schroders has to its customers under the Financial Services and Markets Act 2000 (as amended from time to time) or any other regulatory system. Schroders has expressed its own views and opinions in this document and these may change. Reliance should not be placed on the views and information in the document when taking individual investment and/or strategic decisions.
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Source: ETFWorld – Schroders
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