UK bond issuance set to surge to highest level in nearly a decade

Bloomberg

UK bond issuance is set to surge to the highest level in nine years with Prime Minister Boris Johnson’s government expected to unveil a significant increase in budget spending.
Sales of gilts will rise to 166 billion pounds ($218 billion) in the 2020-2021 financial year, according to the median forecast of 13 bond dealers surveyed by Bloomberg.
The nation’s budget announcement on Wednesday coincides with an unprecedented bond rally that sent yields on short-term UK benchmark bonds below zero for the first time this week. If rates remain negative, investors may end up paying the government for the privilege of holding its bonds.
UK bonds have benefited from a worldwide flight to safety amid concerns over the fallout of the coronavirus, with yields on gilts maturing out to the next half century falling to record lows. That’s good news for Johnson’s Conservative government, which is seeking to increase spending in order to bolster post-Brexit Britain.
“Market momentum this powerful will not be reversed by even a very large supply shock,” said John Wraith, a UK rates strategist at UBS Group AG in London. “Negative yields are clearly a possibility, especially in safest, shortest issues.”
The scope of estimates from primary dealers of UK government bonds, known as gilt-edged market makers, was broad ranging.
The most conservative — Morgan Stanley — sees a supply of 146.3 billion pounds, while Nomura International Plc estimates an increase to 185 billion pounds. That’s a level not trumped since former leader Gordon Brown oversaw a record 228 billion in 2009-10 to help extricate the country from the financial crisis.
Now that Johnson has delivered on his election promise to “get Brexit done” after years of political turmoil, to retain support he must address the concerns of those in some of the poorest regions of the United Kingdom. That requires funding for infrastructure, health care and job creation.
Finance minister Rishi Sunak on Sunday hinted the nation’s fiscal rules could be ditched as he prepares a massive package of measures to tackle the
coronavirus crisis.
For Citigroup Inc., Johnson’s spending is unlikely to be a one-time boost and could just be the start of a much-higher borrowing spree over the course of the next few years. The bank has already revised its estimate higher — to 170.4 billion pounds — due to an “underfund” the previous year. But even that may be too conservative.
“A fiscal splurge — taking advantage of low debt servicing costs — seems highly likely,” wrote Jamie Searle, a strategist at Citigroup, in a note to clients. “It might be prudent to add in some fiscal contingencies now for the developing coronavirus outbreak.”
The rising bond supply is still likely to be mopped up by investor demand for safe assets, given investors are betting on central bank stimulus to tackle the impact of the virus. The Bank of England is increasingly expected to follow the Federal Reserve in cutting interest rates significantly at its next meeting on March 26, or even before.
Yields on two-year and five-year gilts fell below 0% Monday as markets were buffeted by escalating fear over the coronavirus and a sharp drop in oil prices. They bounced back on Tuesday, with the rate on two-year bonds rising 14 basis points to 0.22% as of 9:40 am in London.
Traders in money markets are currently pricing in around 40 basis points of BOE rate cuts this month. Mizuho International Plc strategist Peter Chatwell said that they could even choose to lower rates the same day as the budget.
“If a fiscal package is announced at the same time as a monetary easing package — even if it’s only a rate cut for now — then current low yields can probably be reinforced,” said Chatwell, the London-based head of European rates strategy at Mizuho. “This is where the power of a coordinated effort would be very helpful for both the tax payer and the BOE.”