LDI chart update: Is the price now right?

Gilt yields have been rising relative to swap rates over the past year and a quarter as the market has found a clearing price for the significant increase in gilt supply. Current levels are comparable to the previous highs in 2016 when other factors were at play, namely the impact of new bank regulations, higher repo rates and the introduction of Solvency 2. Interestingly, we believe the latest pause in the cheapening of gilts over swaps may arguably have seen certain investors such as insurers begin to tactically favour gilts.

There are a number of aspects which we believe could impact pricing in the coming months and over 2024. In the first instance, this includes the 6 March UK Budget. There is also the new 2024/2025 gilt remit from the Debt Management Office on the same date, where a lower proportion of issuance is anticipated from both long-duration and index-linked gilts. In addition, watch for how much gilt issuance is reduced to cater for National Savings & Investment and the planned issuance of treasury bills.

The potential opening up of gilt investments to retail investors, by making the process easier, will be worth keeping an eye on in 2024 and beyond. A recent development in February was allowing retail investors to participate directly in gilt auctions. However, to put that in perspective, Italy is a market where they have introduced government bonds explicitly for retail investors in the form of BTP Futura, so there remains more which could potentially be done.

Turning to the Bank of England (BoE), a small tailwind for long-duration gilts arrived in the fourth quarter of last year thanks to changes to the split of bonds sold by the BoE. This in effect meant that the proportion of longer-duration bonds sold (which have reduced more in value) was set lower than had been the case. The next announcement from the BoE is scheduled for 22 March 2024.

Meanwhile, there has been the recent report from the Treasury Select Committee with the headline that “Bank of England has taken a leap in the dark on quantitative tightening, Treasury Committee concludes”. While we do not believe this is likely to have any immediate impact, could it be a catalyst for a potential future change in the manner in which the BoE implements quantitative tightening?

The million-dollar question (or maybe it is a £250 billion question?) remains whether gilt yields have now found a new range versus swaps or is this simply a pause before a further drift higher? Unfortunately, there is no easy answer to this; our expectation would be that the technical factors around supply and demand continue to drive pricing for the time being.