Stheeman acknowledges a tricky market for GEMMs
DMO CEO Sir Robert Stheeman today acknowledged that GEMMs are operating in a “difficult and tricky market.” The global surge in yields, punctuated by bouts of flight to quality rallies, provided “challenging” conditions for primary dealers the DMO chief accepted, although he reminded Total Derivatives that some dealers were expressing concern not that long ago about the low level of yields and a lack of volatility.
Gilts greeted the DMO's new Remit and the larger-than-expected fall in issuance positively with yields 6-8bps lower on the day, long breakevens a touch wider despite the nominal rally, and asset swaps mostly 0.5-1.0bp richer beyond about 5y.
Speaking to Total Derivatives after the DMO’s Remit showed planned gilt issuance for 2022/23 of £124.7bn around £25bn below the average of market forecasts, the UK bond chief said that the DMO would continue to “do what we can to support the market as much as possible” in these choppy markets, with the aim of allowing for “smooth” price adjustment to shifts in supply and demand.
Whether the drop in gilt issuance in 2022/23 – possibly offset by gilt sales by the BOE later this year if Bank Rate rises to 1% - helps or hinders market functioning is moot. However, the Remit contains no new measures to assist the GEMMs even after a squeeze on certain short gilts led to the DMO’s standing repo facility being triggered last month.
Linkers’ share of issuance to increase
As for the distribution of the £124.7bn in gilts to be sold in 2022/23, a rise in the proportion of linkers from 11.1% (as planned in March 2021) to 14.9% of planned issuance caught the eye given the acceleration in RPI inflation and a previous move to reduce inflation risk in the UK’s debt portfolio.
Stheeman points out that 14.9% would still be well below levels before 2018-19 in the range of 20-25%. He adds that, given past reductions in the share of issuance devoted to linkers, (it fell to 6.9% in 2020-21) “they are no longer rising (as a share of the debt) in an unconstrained fashion.”
The DMO head also highlighted out the continued advantages of index-linked gilts. “They’ve traditionally been cost-effective versus conventional gilts of the same maturity,” he says, a view supported by some interesting modelling in the Treasury’s latest Debt Management Report (link), at least up to certain inflation limits.
The DMO always aims for regularity and predictability as one of its core principles, and Stheeman also points to continued “firm demand” for linkers from long-term savings institutions.
Still, inflation-linked gilts remain to linked to RPI rather than CPI and the OBR’s latest forecasts, prepared for the Spring Statement, underline how expensive this will be over the next few years. The OBR sees RPI inflation averaging 10.3% in 2022-23 and 3.6% in 2023/24, compared with CPI at 8.0% and 2.4%.
The OBR also highlights that until the ONS publishes its final decisions, much remains uncertain about the impact of the April 2022 council tax rebate, the energy rebate and the energy clawback on the inflation index. The OBR, for its part, has assumed that all three have no impact on RPI but has said that this assumption may be revised.
Medium gilts trimmed
The biggest drop in planned issuance announced today is in medium gilts, where supply is expected to fall from 28.4% (£55.2bn) in 2021/22 to 21.2% (£26.5bn) in 2022/23. Total Derivatives asked the DMO about that drop, given the importance of mediums and the gilt future to overall market liquidity. But Stheeman highlighted the results of the debt agency’s most recent consultations with the market, as summarised in the Debt Management Report: “While medium-dated conventional gilts remain the most liquid and traded part of the gilt curve, market feedback supported a lower proportion of issuance in this sector.”
Two syndications in the next quarter
A key aspect for primary dealers is of course the syndication programme. The DMO plans to keep the number of syndications at five in 2022/23, split between £13bn in three long conventional syndications and £8bn in two linker syndications. Given that Green gilt issuance is expected to focus on re-openings of the two existing lines to build liquidity in the issues, it is possible that the syndications will be reserved for brown gilts in 2022/23.
Finally, the DMO today also published the agenda for the quarterly market consultation meetings on March 28 (link). Among the key points are plans for two syndicated offerings in the coming quarter - one for an index-linked gilt in the second half of April 2022, and the other for a long standard conventional gilt in mid-late June 2022. Ten auctions are expected to include the 2033 Green gilt on May 10, longs on Apr 20 and May 17, and linkers on May 24 and June 28.