Monday, 21 May 2018

On apologies, linkers and losers

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While the rest of the world is focused on important things like the general strike in Greece, the civil unrest in Spain with all the consequences in Catalunia, on German push-back, the US Presidential election, the cutting back of Japanese car production in China and the prospect of a very soft quarterly Tankan Survey coming out of the Bank of Japan, we here in the UK have our own little issues to deal with.

Anthony Peters, SwissInvest Strategist

Here too, we have the headline acts. The Liberals, tied in coalition with the Conservatives, are holding their annual party conference where they are trying to get their heads around the concept that sniping in opposition is so much easier than being sniped at in government.

More to the point, they have to learn that they aren’t really in government but that they are the junior party in a coalition and that they have not, as the keep apologising for, broken their electoral promises; they simply have not had the opportunity to implement them. The reality of government isn’t anything they were prepared for after nearly ninety years in opposition and they are learning far too slowly how it actually works. Maybe they should return to their constituencies and prepare for final electoral annihilation.

The idea that you can hedge is no more than an idea, for no matter how fast you move, the market always seems to move faster.

However, in markets there was a real “silent killer”. Buying inflation-linked gilts at the point of issue has been the biggest free lunch in UK capital markets in a long time. Who can forget the launch of the 3/8% ’62 linker which the Debt Management Office priced at 94.869 on October 26th last year, a real return of 50bps and which traded up to 102.37 on the day. A week later it was at over 111.00 and the price peaked at over 131.00 in January of this year which represented a negative real return of just over 20bps. Alas, yesterday the DMO syndicated a £4bn of a new 40 year linker, the 1/4% 3/2052 at 96.062, a real return of 35.7bps. Then it all began to go horribly wrong.

Given the long duration of the bond, minor adjustments in the yield lead to significant fluctuations in price but if you are an investor out there and you wake up to find the bonds a point and a half lower with no bids in the street, you want to know what has happened. The aforementioned 2062 issue has lost 5 points since the close on Friday and for some reason, the street is in lock-down. Having been the investment vehicle of choice for so long, linkers look to have suddenly caught something of a cold. The front end of the linker curve has also demonstrated some volatility but nothing in comparison with the long dates –  the ’62, having been as high as the 130s, are now trading at 102.00. Breakeven is around 2.80%.

I have been out there when government bond markets have gone “offered only” and it’s not a nice experience – and, just to make the point, no better or no worse when the go “bid only” either.  The idea that you can hedge is no more than an idea, for no matter how fast you move, the market always seems to move faster.

Fossils and elevators

Steve Beck, a living fossil in both the Gilt and the Treasury market, used to refer to “up by the escalator, down by the elevator” to explain how it feels when the foundations crumble under your trading book. However, the volatility which P&Ls used to suffer as a matter of course are now becoming politically incorrect and the best way to please management, the regulator and all stations in between is to not answer the phone and to “reject” all enquiries on the screen based platforms. To see GEMMs (Gilt Edged Market Makers) quoting the new linker, a £4bn issue on the day after syndication in £250k x £250k has me scratching my head. Maybe those old days when the street was made up of Essex and New Jersey cowboy traders weren’t all that bad after all.

Cowboys they might have been, but LIBOR, for example, worked. The introduction of highly educated and even more highly qualified people into the industry seems to have brought with it such messes as UBS’s Alpha-One fiasco and the likes of Kweku Adoboli and SocGen’s Jerome Kerviel.

So, while the Greeks throw tomatoes and the Spaniards sweep up after recent demos, we here in London will be picking up the pieces of yesterday’s linker syndication and we might need to review how we value the bonds.

However, and despite all the problems, so long as the key inflation measures are still higher than the coupons on new highly rated ten year corporate credits, linkers look just fine to me.                          

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