The Budget announcement on Thursday 7th March 2024 was in line with the updates made to the gilt remit (the UK Government’s borrowing schedule), being consistent in factoring in the announced changes to spending and taxation. As the Budget produced few surprises, the same could be applied to the remit, with many market participants predicting close to the reality of gross gilt issuance of £265.3bn in the next fiscal year. This will be the second largest gross issuance on record (beaten by Covid); yet once quantitative easing/tightening is factored in it will become the new high watermark for net issuance at c. £204bn. What has changed is the composition of the supply coming to the market. Despite the increase in stock there will be no net supply in Treasury bills (typically short-dated issuance up to 1 year in tenor). Index-linked gilts remain constant in value terms but a decrease in proportion; but the most significant alteration is the reduction in long issuance (reduced by 3.1%) and its replacement in medium tenor issues. Overall, this reduces the average maturity of gilt issuance to an historic low of c.12 years.
The market digested the Budget and remit well given the signposting and lack of surprise in the numbers. In terms of performance, this is positive at the margins for longer maturity bonds (15-year plus) however fundamental questions remain about the demand structure for such a substantial supply of government debt. Theories about the death of LDI are overblown, but the likelihood is that gilts need to remain attractive on a yield basis in order to entice additional investors especially from the insurance sector who are sensitive to pricing, in particular versus overseas corporates.
Gross UK Issuance
Source: DMO 7th March 2024
What does this mean for pension schemes’ LDI portfolios?
The continued imbalance (excess) of supply relative to demand is likely to mean that gilts remain the more attractive hedging asset vs swaps, supporting the case for biasing a hedging portfolio towards gilts. However, sporadic buying of gilts by insurers and overseas investors would create some volatility in relative value, supporting a dynamic approach to hedge instrument selection. The high level of projected issuance is also driving the DMO to consider how best to attract non-pension scheme investors which can only be positive for the market by creating investor diversification, something which was not prevalent during the 2022 gilt crisis.
