Rates Spark: Issuance plans more impactful than political promises

The UK government published the new Budget, and while at first sight the numbers look promising, when looking beneath the surface, gilt investors should be less pleased. The big positive news was that the fiscal headroom was increased from £9bn to £22bn. But decomposing this number shows a large portion of this was thanks to the Office for Budget Responsibility's updated forecasts. Furthermore, most of the fiscal consolidation is actually being backloaded, with virtually none already coming into effect in 2026. The Budget discussion is therefore likely to make a return in the future.

With the 10Y gilt yield a few basis points lower in the aftermath, investors seem reasonably content with the chancellor’s efforts to contain the government’s debt. Yet at least part of the nudge lower in gilt yields was probably due to prudent positioning going into today, given there was a non-negligible risk that the Budget would fail to show credibility. For now, there is some relief, but as mentioned above, we may very well face more uncertainty again in the near future.

The biggest winner of the day was actually 30Y gilts, which recorded an impressive 15bp yield drop on the publication of the new issuance plans. The Debt Management Office (DMO) has reduced the share of long gilt issuance down to just 9.5%. For context, the share was 20% in last year’s budget and above 30% in 2021. The trend is important here because it shows the willingness of the DMO to contain the record-high yields. A key reason for reducing longer-dated issuance is the lower demand from UK pension funds, which have slowly been moving from a defined benefit to a defined contribution system.

Also, the eurozone should contemplate reducing the issuance of 30Y bonds to address a reduction in demand. The yield on a 30Y Bund is some 60bp higher than for a 10Y and this spread can still rise going forward. Pension funds are historically an important buyer, but with the Dutch pension reforms on our doorstep, the demand will be structurally lower. To put the potential impact in perspective, the Dutch central bank writes that Dutch pension funds are expected to unwind €100-150bn worth of government bonds and swaps with a maturity of more than 25 years. The total size of government bonds with such maturities is only around €900bn. Without adjustments on the supply side, the upward pressure on yields can therefore be significant.