UK DMO CEO Stheeman on cuts in longs and linkers

DMO CEO Sir Robert Stheeman today acknowledged to Total Derivatives the scale of the reduction in gilt issuance announced in the agency’s latest remit (link).

Thirty-year gilt yields closed as much as 18bps lower after sharply re-pricing in response to the cut in future supply, while 10y yields are down 12bps and back under 1%. The move in the curve began before the Chancellor’s Budget but gathered speed after the DMO surprised the market with a larger-than-expected £57.8bn cut in gilt issuance over the remainder of 2021-22, versus bank forecasts for a reduction in the range of £20bn-£40bn.

“In all fairness to the market, it’s largely a function of the reduction in the OBR’s forecast for the CGNCR,” Stheeman noted. The OBR reduced its forecast by £82.8bn today from the Budget on March 3rd, 2021.

In general, given the massive swings in planned gilt issuance over the last few years – first higher and now lower – Stheeman felt that under these circumstances that primary dealers, investors  and the DMO had “coped exceptionally well”.

Primary dealers had continued to provide liquidity for the market even in volatile conditions such as today’s re-pricing in response to new information.

Within the envelope of the forecasts produced by the OBR, the DMO makes its decisions about how to distribute a reduction in supply. For linkers, Stheeman stressed that the proportion of inflation-linked issuance within the (reduced) total had increased by 2.3 percentage points, compared to the remit revision in April 2021 to 13.5%.

He added that the  DMO had also preserved the November linker syndication and was mindful of the strong demand for inflation seen globally this year. The DMO wished to ensure a well-functioning UK linker market after both a strategic move by the Treasury to reduce Government exposure to inflation risk, and the RPI-CPI consultation, had led to reduced linker issuance in recent years.

Still, with the benefit of hindsight, Total Derivatives suggests that the decision not to increase the government’s exposure to inflation risk has proved well-timed. The OBR today forecasts a rise in RPI from 4.9% in September 2021 to 5.4% in January 2022 “a key month for interest payments on index-linked gilts,” it says. And while the rise in RPI may be temporary the OBR still expects RPI to be running at 2.9% at the end of its forecast, even with the wedge over CPI seen narrowing back to 90bps by 2026 as house price inflation slows.

Given that the biggest market reaction to the remit was seen at the long end of the nominal gilt curve, how did the DMO decide to cut issuance of longs by £13.3bn? Again, Stheeman highlighted a rise in the proportion of long gilt issuance to 30.7% from 29.0%, within a sharply reduced total.

He also stressed that short gilts had seen the largest cut in cash terms, as well as a decline in their share of the total to 27.5%.

Finally, as gilt issuance moves back down towards pre-pandemic rates, Total Derivatives wondered whether the DMO chief was looking forward to taking longer lunches. Stheeman was quick to refute any such idea, reminding Total Derivatives of the DMO’s daily cash management operations and also pointing to the long-term, “illustrative” financing projections published in the remit. Thanks to a high level of gilt redemptions for the next four years, the financing requirement is set to decline only slowly to £187bn in 2025-26. On that basis, the DMO won’t be able to order the full five courses for a while.