Fixed Income  

Gilts face tougher time as auctions struggle

Gilts face tougher time as auctions struggle

The low demand witnessed in a recent UK debt auction has prompted questions about future investor appetite for gilts.

After some auctions struggled last year, the UK Debt Management Office (DMO) held an auction for £4bn of 1.5 per cent five-year gilts on January 20, but only received £4.3bn in bids.

The outcome, labelled “dreadful” by analyst Marc Ostwald of brokerage firm ADM, represented the lowest demand since a 40-year gilt auction failed at the height of financial crisis in 2009 – and has sparked debate over the outlook for UK government bonds.

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Chris Bowie of TwentyFour Asset Management suggested banks and other players had been too preoccupied with market volatility at the time of the auction to take part.

And while he believes the low demand does not represent the start of problems for the wider gilt market, he said weak sentiment may continue to hit auctions in future.

“If the market’s in a risk-off mood and banks are pulling back their bid pricing, it’s difficult for investors to decide to put their cash to work,” Mr Bowie said.

“A lot of this is dictated by weak sentiment. The gilt market could see a few auctions that are harder to get away, but the market’s still very strong.”

Gilts have rallied again at the start of 2016 as equity market volatility pushes investors into safer assets. But the looming referendum on the UK’s membership of the European Union, and regulatory pressures on banks, have dampened appetite for government debt.

John McNeill, co-manager of the Kames Absolute Return Bond fund, said uncovered auctions were more likely because of the dearth of ‘market makers’ who typically buy debt at such auctions to sell on elsewhere.

These market-maker roles have typically been occupied by banks, but regulatory changes have made it less attractive for such firms to hold bonds on their own balance sheet.

A failed auction could “raise eyebrows” among UK investors because of its rarity, he said. But Mr McNeill stressed it would not equate to a “vote of no confidence in the UK gilt market”.

He said: “The signal effect of an uncovered auction, because it’s so rare in the UK, would be to raise eyebrows. But I think it would be a temporary effect. If we had an auction tomorrow and it was uncovered, an auction the next week would cheapen up.”

Other managers were relaxed about the prospect of uncovered auctions.

Mitul Patel, head of rates for Henderson Global Investors, said: “Unless you see repeated uncovered auctions this is not a cause for concern.”

Matthew Russell, manager of the M&G Short Dated Corporate Bond fund, added: “I think the growth rate, unemployment and level of inflation in the UK provide much more information on the prospect of gilts than the level of interest in auctions.”