Traditional government bond holders such as insurance companies and pension funds have faced stiff competition since the financial crisis. Their combined share of issuance has gone from c. 60% to approximately one third whilst the Bank of England, and to a lesser extent overseas investors have largely taken up the differential 30%. Each of these investor types have different ‘sweet spots’ where they prefer to invest and by wielding judgement as to how these sectors will evolve, the DMO can tilt its issuance to match the keenest demand. This is vital as ultimately the DMO’s job is to issue debt at optimal yields, and increased demand will allow the DMO to be thrifty in the long term by driving down the cost of borrowing.
Pension funds have historically focused on longer tenor & index-linked issuance whereas overseas investors typically favour the short end (this sector includes global central banks). If we had asked a question about the make-up of the investor base a mere few months ago, it is likely that our counterparties would have promoted the spectre of an unwind of the QE portfolio. This attitude has undergone a wholesale shift, with none of our counterparties expecting this to occur for a significant period, indeed current guidance suggests that the Asset Purchase Facility (APF) reinvestments will persist until the Bank Rate has reached the lofty heights of 1.50%. Projected reinvestment flows total £36bn in 2019, £19bn in 2020 and £59bn in 2021.
Overseas investors are expected to remain net buyers, in particular in the sub 5-year sector, although there is an element of risk and potential volatility around Brexit and a possible general election. The absolute amount of supply also has an impact on sector allocation. This year, outstanding issuance has risen to £114.1bn and is expected to rise further in the subsequent fiscal year. Beyond this point the supply is forecast to decline slowly. Some of our counterparties have highlighted that the risks to total supply are very much to the upside as the estimates by the Office for Budget Responsibility (OBR) could be described as leaning to the more optimistic side on taxes and privatisation revenues.
Equally there is the potential for a loosening of fiscal policy with a new Conservative leader and the potential for even more loosening in the event of a general election and a Labour win. This is relevant as when there is heightened issuance, the DMO will typically focus on shorter duration supply so as to ensure that the market can digest it.
The chart below represents the total level of issuance and the allocation to the different sectors. Shorts = 0-7yrs, Mediums = 7-15yrs, Longs = 15yrs+