UK DMO’s Stheeman on supply, GEMMs and gilt volatility

DMO’s Stheeman on 2022’s third 2022 revision

The DMO chief Sir Robert Stheeman talked today about the debt office's third revision to its financing remit for 2022 (following similar events in April and September). The headlines were a smaller than expected total of planned gilt sales, a mere £169.5bn, versus an expected £193.9bn in Sep and market consensus forecast of £185bn, with a slightly higher percentage of short gilts (39.2% versus 37.9% in Sep) and mediums (25.5% versus 24.0%) and slightly smaller shares of longs (23.5% versus 24.2%) and linkers (10.0% versus 10.9%).

He said the decisions regarding the issuance split were “a judgment call. We try to strike a balance between structural demand and the need to cater for a diverse investor base. And with £72bn to raise in the next four-and-a-half months, including the quiet Christmas and New Year periods, market conditions are still challenging, which we are trying to take into account.”

And with super-wide short-dated ASWs it would seem that the front-end is still feeling a bit starved of free-floating gilts, although the post-Budget moves (2y yields up 12.5bps or so versus 6.5bps in 10y might suggest otherwise). Stheeman wondered if the front-end weakness might suggest “that people, were expecting a greater reduction in short-end supply (down to £66.5bn from £73.5bn in Sep), but we’ve cut issuance in all areas and types of gilts.”

As for the drop in planned long-dated gilt issuance (£47bn in Sep to £39.8bn in today’s remit), Stheeman said that the reduction “is less about LDI demand – although longs have had a challenging period of late – and more about strong demand for short and medium-maturity gilts."

Also heading lower in supply terms were linkers, down from a planned £21.2bn in Sep to £17bn today (a £4.2bn drop). Stheeman said that linkers, significantly more costly to the government than they were as recently as June (10y real yields are +165bps and RPI hit 14.2% in October), are going nowhere. “Linkers do represent very good value for money for a significant part of our investor base so we will continue to supply them. And it is good to see that long-end linkers are still very well bid at the moment, ahead of the linker syndication next week.”  

As well as Chancellor Hunt’s Budget today, the OBR produced its updated report, coming up with an array of gloomy predictions including a sizeable gross financing requirement over the medium tern. This would suggest yet more busy years ahead for the DMO but Stheeman refused to get dismayed, saying today that “just as a general view, I am always quite sceptical about long-term forecasts.”

Stheeman hopes volatility makes for happier GEMMs

Looking at the hardy pack of banks that form the GEMMs, Stheeman hoped that some of them at least will have been cheered by the remarkable market volatility of 2022 in general, and the last couple of months in particular. Throughout 2017 and 2018, for example, 10y gilt yields traded in an 80bps range (0.85% to 1.75%) and “countless times that GEMMs have complained about the limited opportunities in such a low-volatility market.”

In 2022, the 10y has tried hard to make up for its quiet years, trading in a 433bps range (0.17% to 4.5%) with record levels of intra-day volatility. Stheeman said he hoped that “while some GEMMs may have found conditions tricky at times, hopefully they may still have come out of it quite well.”

And talking of GEMMs, Stheeman confirmed that the DMO will stick to its usual practise of not actively seeking to recruit new members to the group. “We don’t actively seek GEMMs,” he confirmed. “Market forces determine the number… we’ve had a stable number of fifteen for a few years now although if a bank approached and said that it was interested we would happily engage with them. We don’t have a fixed number in mind of how many is appropriate, but it is more driven by supply and demand, by terms of profitability, bid/offer spreads, and whether a bank sees that being a part of that would be good for their business.”

Bear-flattening in wake of remit

The gilt curve bear-flattened as the market reacted to the Budget, the accompanying DMO remit, and possibly allowed itself to express some bearish worries that were supressed yesterday with the release of an 11.1% headline CPI number, which also triggered some bearish words from the BOE’s chief economist Huw Pill today.

As mentioned above the total DMO remit for the remainder of this year is below expectations, but next year’s looks heavier than most banks forecast with the 'illustrative' gross financing requirement for the DMO at a lumpy £305bn.

Speaking in Bristol today Pill said that “What is key for us at the Bank of England is to ensure that that one-off potential impact on inflation does not become embedded into wage behaviour and into pricing behaviour,” warning that the BOEs activity was not yet over. SONIAs fell by 13-15bps in the reds and 7-11bps in the greens. 

So after a good run that saw the 2y yield drop from 4.60% at the end of September to 3% yesterday, some profit-taking/re-pricing of BOE risk clearly did not seem unreasonable to the market.

Strategists at RBC looked at the short-end ASW cheapening post-remit today and suggested that a “This reaction is rather interesting given that gilt issuance in FY 22/23 was revised down more than the market was expecting. This could be further evidence that the market is looking beyond the immediate impact to FY 22/23.”

In any case, it said, “in H2 of FY 22/23, we will still see a highly positive net supply of short gilts post QE/QT. The only event on the horizon which we see in the way of short-end ASW cheapening is the redemption of the 0e23s on 31 January 2023 – which will result in a record amount of redemption proceeds circulating back into private investor hands which can be reinvested back into the short-end.”

“However, historically we see these flows only begin to impact the market from a round a week prior to the event. We therefore continue to see ASW spreads tightening across the curve over the medium term and continue to recommend our 30y ASW spread tightener position.”

Finally in linkerland, the supply dynamics did have the logical effect, with IL73 RYs closing a couple of bps lower at -44bps ahead of next week’s reduced-size syndication, while breakevens rose 7bps to 3.22%.