UK Rout Deepens as Reeves Budget Worries Spread Across Markets

Heavy Supply

The Debt Management Office on Wednesday said it will sell £297 billion ($386 billion) of government bonds this fiscal year, its second-biggest target on record. While that was only slightly higher than expectations, investors pointed to official projections that imply around an extra £142 billion of borrowing over the next five years.

The funding will go toward what the independent Office for Budget Responsibility described as “one of the largest fiscal loosenings of any fiscal event in recent decades.”

This is “not a healthy repricing in gilts,” said Megum Muhic, a strategist at RBC. “It seems like the market isn’t convinced the spending measures announced will be able to drive growth in the UK, and on top of that, you have more gilt sales.”

The pain for UK assets is a shot across the bow for other nations around the world, many of which are embarking on their own chunky funding plans. Investors in US assets are bracing for whoever wins the presidential election next week to initiate an aggressive spending plan that’s likely to bolster borrowing and the deficit. Wall Street veteran Ed Yardeni warned this week that “it’s a conceivable scenario that the bond vigilantes are definitely mounting up.”

It’s also a setback for Reeves, who’d gone to considerable lengths to prepare markets for her borrowing plans, signaling her intentions while at the International Monetary Fund’s annual meetings last week. Declining gilt prices are politically sensitive, given how often the Labour government has slammed the market selloff triggered by Truss’ mini-budget.

Reeves sought to reassure financial markets, saying the “number one commitment” of the Labour government is economic and fiscal stability. “We have more headroom than the previous government left us, and that is important,” Reeves said Thursday in a Bloomberg TV interview. “We have now put our public finances on a stable and a solid trajectory.”

Inflation Outlook

This week’s moves round out a rough year for UK bonds, which have underperformed peers on the view that the BOE will lag the European Central Bank and Federal Reserve in loosening policy. A Bloomberg gauge of gilt returns is down around 3% since December, versus a 1% gain in comparable indexes of euro-area and US government bonds.

The disorderly price action on Thursday saw UK bonds again diverge from global peers, and was exacerbated by investors getting stopped out of so-called curve steepeners, according to traders. The spread between two- and 30-year gilt yields narrowed to seven basis points. Some investors also closed trades for gilts to outperform versus other bond markets, they said.

“As ever in UK markets, illiquidty is exacerbating moves,” said James Athey, fund manager at Marlborough Investment Management. “With the US election now looming and the potential for more bond unfriendly news there we might struggle to easily find willing buyers so the potential for an overshoot is very real.”

Among fiscal measures announced this week, the government increased the minimum wage and a tax on employers known as national insurance contributions. The OBR said the total package would add 0.4% to inflation over the next two years and lift the BOE rate by a quarter-point over what investors were expecting.

While headline price gains in the UK have slowed to below the BOE’s 2% target, inflation in the services sector is still running at an annual 4.9%.

“Bond markets are on edge around all things fiscal and the gilt market is no exception,” said Jack McIntyre, a fund manager at Brandywine Global. “More spending, more issuance and slightly more taxes. Not what the bond vigilantes wanted to hear.”

Still, bids for a sale of 30-year green bonds on Thursday came in at 3.15 times the amount on offer, underscoring healthy appetite to lock in the higher yields on offer. Open interest — a gauge of outstanding positions in UK 10-year bond futures — remained broadly unchanged this week, which suggests traders have not changed their bets on the future direction of gilt yields.

“The immediate concern for the market would be fiscal expansion funded by long-dated issuance,” said Mohit Kumar, chief European strategist at Jefferies. “We are not expecting any Liz Truss moment, but expect fiscal concerns to keep pressure on the long end.”

–With assistance from Anchalee Worrachate, Ellen Milligan, Joe Easton, Joe Mayes and Kit Rees.

(Updates prices, adds Reeves’ comments from her Bloomberg interview on Thursday.)

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