THERE WAS a time when the so-called “bond market vigils” could intimidate governments. “During my career, we went from rottweilers to poodles,” says a veteran of the market for 35 years. “You would go to meet the Treasury and say that the market will not carry it. Now, you are just grateful to buy something that has a positive return rather than a negative one.”
Since the 2007-2009 financial crisis, Britain has lost its AAA credit, given its debtGDP The ratio went from 40% to over 80% and voted for Brexit. And yet, over the same period, the yield on gilts, the ten-year benchmark government bond, fell from around 4.5% to less than 0.5%. In this, Great Britain is not alone; interest rates have fallen in advanced economies. This week, the yield on gilts hit a historic low below 0.4%, and the equivalent yields on US and German public debt fell below 1% and -0.6% respectively. The vigilantes do not seem very vigilant.
This record cost of borrowing was reached before a budget, expected on March 11, which most investors expect to see an increase in borrowing. The new Chancellor of the Exchequer, Rishi Sunak, is expected to largely revise the tax rules inherited from his predecessor, either in this budget or later in the year. Britain now seems ready to get its sixth fiscal framework in a decade. The types of bond markets reacted with a shrug rather than a panting.
Fiscal rules are supposed to guard against the propensity of politicians to go into debt by setting rules on the appropriate level of borrowing. These rules are, in theory, intended to reassure investors in UK public debt that they lend to a credible counterpart. But investors are paying less attention to it than politicians could imagine. According to Chris Jeffery of Legal & General Investment Management, an asset manager, “Tax rules are a political roadmap: they help keep government modesty, tend to irritate the most sensitive areas of government, and don’t last not very long before needing to be replaced. . “
The delicate area which is irritated in this case is that of ministerial expenditure. The current rules allow plenty of room for new capital projects, but they are committed to balancing the current budget within three years. Promises to increase spending on the National Health Service, hire 20,000 new police, and protect school funding while reducing payroll taxes mean pressure on other departments and local government. The need for a political response to covid-19 puts additional pressure on the existing budgetary framework. After falling by about 10% of GDP in 2009 at less than 2% today, the public deficit will probably start to climb again. It’s less of a problem than many assume.
Britain’s current stock of public debt may be high, but the cost of service is extremely low. In 2018-2019, the net interest bill represented only 1.7% of the GDP, the lowest in all years since the Second World War. Cost of borrowing represents only 4.5% of tax revenue, well below the government’s rule to keep it below 6% (see chart). Demand for gilts has been high for two decades, which has reduced yields.
The role of the Bank of England, which bought more than £ 400 billion ($ 512 billion) in public debt as part of its quantitative easing program between 2009 and 2016 and now holds around a quarter of ‘outstanding debt, caught the attention. . But in the longer term, the demand from foreign exchange reserve managers and national pension funds has been greater.
Gilts benefited from a sharp increase in global foreign exchange reserves in the 2000s. As the governments of East Asia and the Middle East increased their reserves, gilts appeared to be attractively priced compared to d other forms of secure debt. The share of the British pound in world reserves has risen from less than 3% in 1999 to around 4.5% now. This money turned out to be sticky, and an increase in British borrowing should not cause managers to panic. “The obvious stress test was in 2008,” when government borrowing surged during the banking crisis, said Moyeen Islam, a gilded strategist from Barclays. If foreign holders did not get rid of their gilts at the time or after the Brexit referendum, it is unlikely that they will do so in the face of a modest relaxation of the purse strings. “Where are they going to go elsewhere?” Italy? Asks a global fund manager. Choosing bonds is sometimes like removing the least dirty shirt from the laundry basket and, compared to some peers, Britain does not look too wrinkled.
National pension funds and insurance companies hold about a third of the stock. Defined benefit pension funds, in particular, have sought to secure long-term sources of fixed income to match their commitments. Although most of these plans are closed to new members, they still control over £ 1.5 billion in assets. Their demand for gilts over the past 15 years has been “almost insatiable,” says a broker. Bonds represented 28% of their assets in 2006 but 63% in 2019.
In an environment of low interest rates with still high demand for gilts, Mr. Sunak will have no problem financing his additional loans. Indeed, some bond managers argue that the government has ignored market pressure to borrow more. Just as high rates in the past were seen as a sign that fiscal policy was too flexible and needed to be tightened, low rates today could indicate that fiscal policy is too tight. “In fact, the markets have been calling for an easier policy in Britain for years,” said Toby Nangle of Columbia Threadneedle Investments, asset manager.
Things could of course change. The higher its debt, the more vulnerable a country is to changing market moods. But the average maturity of the British public debt, at 15 years, is the longest of any advanced economy. Strong demand from pension funds for long-term paper has enabled UK debt managers to gradually extend their borrowing. This maturity profile means that it is not necessary to refinance a large part of it each year and offers protection against any sudden change in world interest rates. If Mr. Sunak wants to spend the money on the budget, the bond market will be happy to oblige. ■
This article appeared in the British section of the print edition under the title “Neither shaken nor stirred”