Saturday, 21 July 2018

Osborne's 100-year bond could be a kite too many

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I had something of an exchange with a chum yesterday after it was announced that the Encyclopaedia Britannica will cease producing its legendary printed tomes in favour of remaining a net-based source of all knowledge. He asked whether I thought he should acquire a copy of the last run.

Anthony Peters, SwissInvest Strategist

I suggested not, for as a collector of rare things, I know that it is less the quality of the item than its scarcity which gives it the value. (I suspect the world will be full of people who erroneously dive on the last of the Britannicas, only to find that there are hundreds of the darned things offered on eBay by like-minded speculators.) Anyhow, my chum took my contention on board and answered: “…. a bit like the 100-year Gilt then in your view?”

Chancellor of the Exchequer George Osborne has proved to be a lot more sensitive in reading the mood of the markets – or perhaps one should say more sensitive in listening to advice on the mood of the markets – than some of his predecessors and certainly than some of his European peers, but the kite which he has flown with a tail made of 100-year paper looks to have landed straight in Charlie Brown’s famous kite-eating tree.

Obviously it would be nice for the Treasury to be able to lock in the low current long end rates but, let’s face it, someone has to be on the other side and be prepared to commit themselves to lending money to the government for a century at 4% or thereabouts.

On Osborne: The kite which he has flown with a tail made of 100-year paper looks to have landed straight in Charlie Brown’s famous kite-eating tree

Looking at the more recent history of Gilt yields, that looks like a pretty bad idea. I don’t have a proper long history available to me here but I do know that the 20-year benchmark has yielded an average of 5.5% during the past 20 years. That looks about right and I would probably be happy to give 100-year at 5.5% or so but at the moment, with a probable 4 handle, I too would be prone to pass. First feedback suggests that I am not alone.

On UK’s ratings review

Meanwhile, overnight, Fitch added its reviewed rating on the UK in which it shifts the outlook to negative but confirms the Triple A status of the country. Although the UK is the second most indebted AAA nation other than the US, it benefits from a consistent strategy of issuing long-dated paper which has it sporting a duration of just above 12 years, way ahead of that of any other developed government debt portfolio.

It is this more than anything else which keeps the UK out of the clutches of the sovereign debt crisis. The enormously stable funding base which depends so little on short-term sentiment and where cash management funding is precisely that has stood the country in excellent stead and explains why it has made it through the recent storms with its Triple A rating more or less intact.

One can understand the French ire as it found itself downgraded when the UK, which has similarly weak if no weaker metrics, was not affected but it is firstly in the skill of the DMO and secondly in the Chancellor’s choice to follow the DMO’s advice and not to succumb to the temptation to front-load the borrowing portfolio with cheap debt which has maintained the status.

However, the temptation to over-egg the pudding in the opposite direction must also be resisted. Yes, I know that the old 3-1/2% War Loan irredeemables are trading at about a 4% running yield and that that is probably the correct price in the context – as are 50-year inflation-linked Gilts at 1/2% real yield – but to issue 100-year paper now would be sending out a different message.

War Loan was … well, it’s in the name, isn’t it? To reach out for 100-year money now would look a bit like when the Greeks issued at 30 years – a need to strap it on while the going was good. This is a time for the Treasury to steer the ship “steady as she goes” and not to embark on ventures which look like acts of desperation. I rest my case.

Be aware of the shift in momentum

Meanwhile, I attended a meeting yesterday in which we discussed the way in which this past quarter has been a blinder for investors. I continue to expect some profit taking into month-end, but would not ascribe too much value to the odd down-day.

Nevertheless, the concern over the growth rates in China are beginning to take hold more broadly and this will play clearly into the hands of the trusty old Greenback. US dollar/yen is weakening and looks to be heading for the 12-month low of ¥85-1/2 – it traded within a whisker of ¥84.00 this morning (it was below ¥76.00 in October). There is a shift in momentum taking place and one would miss this at one’s own peril.

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