UK DMO: Selling more gilts than expected

DMO to sell more gilts than expected

The rise in yields in 2021 has been a “global phenomenon” and the UK has not been “immune”, Sir Robert Stheeman, CEO of the UK’s Debt Management Office told Total Derivatives shortly after the publication of the 2021 Budget and DMO’s financing remit for 2021-22 today. Still, the big underperformance by gilts versus Bunds and Treasuries in the wake of the Budget, suggests that local factors can still exert an influence, and ten-year gilt yields rose by 9bps today.

Gilts began to cheapen from the open as the market digested another extension in the government’s pandemic support measures (see article). However the move gathered steam after the DMO announced plans to sell £295.9bn in gilts in 2021-22, well above the market median forecast of £247bn according to a Reuters survey of banks, which found a maximum estimate of £269bn.

Dealers speaking to Total Derivatives earlier this week stressed the uncertainty around forecasts of the DMO’s issuance numbers – especially the precise allocation to shorts, mediums, longs and linkers. However, that failed to prevent a selloff.

Stheeman today was reluctant to speculate about why the market had missed the number. “You’ll have to ask the gilt analysts” he suggested, not unreasonably. But it seems likely that the government’s spending plans were higher than analysts expected, and hence the OBR’s deficit forecasts exceeded the market’s.

Shorts, mediums, longs or linkers?  

But if the envelope of borrowing and hence total gilt issuance is largely a given for the DMO, how did the Office decide on a 29%/22%/28%/11% split for shorts, mediums, longs and linkers?

“Cost and risk is one factor,” Stheeman explained. “We look for the most cost effective issuance across the curve and instruments.”

He stressed, however, that the DMO, while keeping the average maturity of issuance relatively high to help contain refinancing risk, also acknowledges the importance of meeting demand from investors in all the key maturities along the curve. “We are mindful of that,“ Stheeman said.

At least £15bn in Green bonds  

In terms of innovation, the main development for 2021-22 is the plan for “a minimum” of £15bn in green gilt issuance beginning in the summer of 2021, with the DMO looking to build a green curve over time.

Asked about the cost effectiveness of green versus conventional gilts, and expectations for where a green gilt might price, Stheeman refused to be drawn. However, he did note that the relative value for money equation had shifted recently for other sovereign green issuers, on the back of a rise in demand for ESG assets from investors. Indeed, even retail investors will be able to buy a green product from NS&I at some point in 2021.

Inflation linked issuance takes a bigger share  

For inflation, the conclusion of the RPI review has allowed the DMO to increase the proportion of linkers in its issuance plans to 11%, implying that the cash total will be maintained at very close to £33bn in 2021-22 despite the sharp fall in total planned  gilt issuance from £485.5bn this year, to £295.9bn in 2021-22. Stheeman acknowledged that some of the traditional institutional and pension fund investors in linkers had paused some of their hedging activity while the outcome of the review was uncertain, but could now feel more confident in transacting again. He noted that demand at the last linker syndication had been good. 

Syndications versus auctions  

Ahead, the DMO currently  plans to sell its gilts through 93 auctions worth £237.9bn - 80% of the total - plus six syndications worth £30bn or 10%, comprising £13.5bn in linker syndications and £16.5bn in longs. Still, a significant £28bn of planned issuance remains “unallocated” and while the majority of that would be taken by the expected £15bn+ in green gilt issuance, it would leave some left for additional issuance methods in response to demand.         

DMO, GEMMs to stay busy for years  

Finally, what do the Chancellor’s plans to “begin fixing” the public finances from today’s Budget  mean for gilt issuance over the medium term? Illustrative figures published by the DMO show that after falling from £304bn in 2021-21 to £235bn in 2022-23, gross funding is likely to remain above £200bn a year right out to 2025-26. That should be sufficient to keep the DMO and its GEMMs busy.