By ADRIAN LOWCOCK 27/03/2009
A week is a long time in politics and a very long time in finance.
Gilt auction
The Debt Management Office here in the UK has carried out a gilt auction. Nothing unusual about that, until it ‘fails’ that is.
The auction of this particular line of gilt is at the more difficult, longer-dated end of the market. With a yield of 4 1/4% and maturity date of 2049. long dated gilts with lower coupons (interest) are most susceptible to inflation. It is therefore not a reason to panic but perhaps a reason for investors to consider alternatives.
It does suggest, in the long term, that the market is more concerned about inflation. Partly caused by low interest rates and the Quantitative Easing (QE) that was announced at the start of the month. The purpose of QE was to buy shorter-dated gilts to encourage investors to move to long-dated gilts. The demand would force up the price and drop the yield, making borrowing money over the longer term cheaper. It would also make it easier for the Government to issue long-dated gilts at low coupons as they tried this week. This was working as gilts prices shot up on the announcement of QE, until Mervyn King decide to tell the market he may not spend all of the £150bn at his disposal.
The net effect of both of these events was long-dated gilt prices fell, yields rose and all the good work that was achieved following the announcement of QE, was undone.
With so much political debate surrounding the Governments next moves perhaps gilts are more risky than one would think. Bond fund managers seem to believe so, many have been scaling back their gilt exposure and moving into corporate bonds.
US
Loose talk seems to be infectious, across the pond, the American Treasury Secretary, Tim Geithner, appeared to suggest the US was open to China’s proposal to reduce reliance on the dollar as the world’s Reserve Currency. This sent the dollar tumbling, triggering an embarrassing admission that he had, in fact, not studied the proposal. The reaction of the currency to such a comment emphases just how weak confidence in the dollar is at present. One thing is for sure the issue of Reserve Currency is now on the agenda.
The US also received a lukewarm response to a record $34bn auction of five-year treasuries, highlighting the concerns of a flood in supply. Earlier on this week, the Federal Reserve had purchased $7.5bn of treasuries, the first step of its $300bn buying programme.
Conclusion
The events of this week reflect the markets lack of confidence in the US and UK Governments’ ability to spend their way out of this recession. It is the purpose of monetary policy to bear the brunt of tackling booms and slumps. The concerns of over-borrowing are perhaps exaggerated. When national debt rises the nation throws its hands up in anguish and despair, and yet bankruptcy remains remote. In the postwar period public net debt was, at £27bn, 146% of GDP, about two times what is expected currently, and that was financed at 0.5% bank rate. This was repaid through economic growth and creeping inflation, not much above current targets.