Sometimes ideas come to fruition at the time but others have a much longer gestation period. My subject of today is an example of the latter as it was back in March 2012 that Chancellor George Osborne included this in the UK Budget.
In light of evidence of strong demand for gilts of long maturities and against the backdrop of historically low long-term interest rates, in 2012–13 the DMO will consult on the case for issuance of gilts with maturities significantly longer than those currently in issue, that is in excess of 50 years, and/or perpetual gilts.
By DMO he meant the Debt Management Office which is the body which manages the UK’s national debt. The plan was for it to do this.
The consultation will build an evidence base to inform the Government’s decision on whether to issue such instruments. It will seek to establish the likely strength and sustainability of demand, the cost-effectiveness and risks of issuance, and the impact on market liquidity and the good functioning of the wider gilt market.
If we look at the plan back then we see it was based on “historically low long-term interest-rates” or bond yields. That was true in March 2012 with longer maturity Gilt yields having fallen by a bit more than 1%. If you compound that over 100 years then you would be quids in so to speak as an issuer.
They held an online debate and Jim Leaviss of M&G told us this.
Few fund managers would publically argue that a yield of supposedly around 3.5% is good value given both inflation and political uncertainty over 100 years.
Such things are a hostage to fortune as it has turned out that any fund manager who had bought such a bond would be giving a lecture tour right now on how clever they had been, as well as deserving a large bonus. We should not be harsh on Jim as who could have predicted the last 7 years.
Currently, we are not bullish on the gilt market: it looks expensive and I am not sure you would want to lock in low yields for such a long time period.
Oh well as Fleetwood Mac would say. He did think that a 100 year Gilt would be bought in spite of that being a bad idea.
However, there has been demand for long-dated gilts given the size of the existing 2060 gilt and the 2062 linker of over £16bn and over £8bn respectively.
If a 2112 is issued, its very existence will cause index-led funds or liability matching pension funds to buy it.
Not everyone in the debate felt that it would work and others thought that the Gilt market was already too expensive. Here is Jeff Keen of JO Hanbro.
Assuming the Bank of England is successful in meeting its 2% inflation target, this implies long term gilt yields should be in the 4%-5% range rather than the currently implied yield for a 100-year gilt of around 3.5%. The difference is a downward price adjustment of around 30%. Beware – gilts are not necessarily a safe haven.
Apologies for embarrassing them.
What happened next?
There was no explicit issue although in 2015 we did covert something into a 100 year bond. From gov.uk.
The Treasury will redeem the outstanding £1.9 billion of debt from 3½% War Loan on Monday 9 March 2015.
The reason for that was the 3.5% coupon which in 2012 had seemed cheap was by then looking rather expensive for the UK taxpayer.
You may recall that Austria issued a century or 100 year bond back in 2017 well there is more of it now.
They also revised pricing lower for a tap of Austria’s outstanding debt maturing in 2117 with demand there exceeding 5.3 billion euros. That 1.25 billion euro issue priced at 48 bps over an outstanding Fed 2047 bond, translating to a yield of 1.171%. ( Reuters)
Yes you did read that yield correctly and as pointed out in the comments yesterday there was another sign that it was an issuers party for the Austrian taxpayer.
The country’s debt management agency launched the sale of 3 billion euros of five-year bonds at 23 basis points below the mid-swap rate, translating to a yield of -0.435%. The deposit rate stands at -0.40%.
There was a time when the ECB deposit rate was a barrier for bond yield issuance but as you can see that is now in the past. The bull market for bonds is so strong that it has passed the benchmark and if Germany issued a five-year bond it would blow it away at around -0.6%.
Another sign of how strong the bull market is in bonds is that there was plenty of extra demand for the two issues by the Austrian Treasury. As its overall yield is 2.08% it has improved conditions for the taxpayer there with both issues.
The UK Gilt Market
This has also been in a bull market where yields are both absolutely and historically low. We do not have the levels of much of the Euro area for several reasons. Firstly official interest-rates are lower there with the deposit rate being -0.4% as opposed to the UK Bank Rate of 0.75%. Next we have had ECB President Mario Draghi only recently hint about even lower interest-rates and more QE bond buying. Also with the planned TLTRO money market ( bank subsidy) operation it is in the process of enforcing them.
But we do have very low yields as for example both the two and five-year yields seem to have settled around 0.6%. If we look further out we do have a fifty-year Gilt which yields some 1.38% as I type this. So what is called our yield curve is pretty flat both as a curve and also in comparison with the past.
This seems clear cut to me as at present yields the UK could issue a 100 year Gilt very cheaply. There are loads of projects which would look extremely viable at these levels. If you are wondering how much? Well even if we issued at the fifty-year yield of around 1.4% that would be 2.1% below 2012. Actually if you look at the way the yield curve shapes we might be able to issue at a yield of 1.3%. Amazingly cheap and less than a tenth of past yields experienced in my career.
The flip-side of the coin is that at such a yield the percentages are heavily weighted against any buyers. So buyers of fixed-income funds might do well to be afraid and perhaps very afraid. It is a bit different for holders who have been in a long running party.
As to size well if you do it why not offer £10 billion and see what happens? I would not be surprised to see it be over subscribed.
Meanwhile every idea has its niches. From PolemicTMM.
UK should issue a 100yr zero coupon 42bio Euro-denominated bond to fund the Brexit bill (if bond mkts continue like this, we may even get -ve rates). EU institutions would end up having to buy it due to EU imposed reserve regs and so effectively end up funding Brexit.
By bio he means billion I think. The quid pro quo for an even lower interest-rate would be an exchange-rate risk.
The Investing Channel