Ian Mills, Partner and Head of DB Endgame Strategy at Barnett Waddingham said: “Following the Chancellor's budget announcement yesterday, we have seen a steady rise in gilt yields. This has not been a surprise as the Chancellor indicated an intention to issue more gilts than previously expected by the market. Basic supply and demand principles suggest that when supply goes up this tends to push down prices, and as yields and, as prices are inextricably and inversely related, yields are likely to rise as a result. Demand for gilts will tend to be affected by considerations around inflation and growth. If inflation is expected to rise, gilt buyers will demand a higher yield for the greater expected real-terms devaluation of their capital. If growth is expected to be higher then investors will demand higher yields on gilts because other investments become more attractive. According to OBR analysis, this budget is broadly neutral on growth but is slightly inflationary. This could place further upward pressure on yields from a demand perspective.
“The big question, however, is who is going to buy all these gilts? For the last twenty years or so UK DB schemes have been buying gilts at almost any price. They are, however, now generally very well-funded and own pretty much all the gilts they will ever want to buy. The danger for the Treasury here is that when a DB scheme buys-out most of those gilts ultimately are sold (either by the scheme to pay a cash premium) or by the insurer as they redeploy assets into higher-yielding investments. This could apply further upward pressure on yields from declining pension scheme demand over the next few years. Our view is that this will be felt most keenly in the long-end of the curve and especially in the index-linked market where there are few other natural buyers. The memory of the 2022 mini-budget, which saw rising yields trigger a liquidity squeeze for many DB pension schemes, is still fresh. However, three key differences this time around reduce the likelihood of similar repercussions:
1. The Chancellor involved the OBR in this process, so that investors have independent analysis of the impact of the budget on which to base their decisions. In 2022 the lack of this analysis led to an uncertainty premium feeding into yields.
2. Gilt yields had been rising significantly in the months preceding the 2022 budget, whereas this time they were not materially different to six months prior. In 2022 the rise in yields was already starting to squeeze some schemes' liquidity even before the budget.
3. DB schemes and their asset managers have learnt their lesson - they (generally) went into this budget with far higher targeted levels of liquidity than they did in 2022.
In short, fears of a repeat of the 2022 gilt market crisis are not justified.”
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