The failure of the DMO’s auction (pdf) of 4.25% 2049 gilts - bids fell 7% short of the £1.75bn offered - has led to some hysteria, such as some of the comments here.
I fear, however, that the truth is rather more mundane.
The thing is, gilts are in normal times near-substitutes for each other: 2049 stock is very similar to 2048 stock, which is similar to 2047 stock and so forth. However, quantitative easing has changed this. The Bank will buy gilts (pdf) in the 5-25 year range. Ceteris paribus, this gives gilts in the 2014-34 year maturity range a liquidity premium over other issues.
Now, in principle this new premium should have been embedded in prices immediately, when the policy was announced earlier this month.
However, because QE is a new policy, we can’t be sure how a big this premium should be. All that’s happened with this auction is that we’ve discovered that it should be bigger than the market thought yesterday. It’s just part of the price discovery process.
You might wonder why the DMO is issuing long-dated gilts at all, when it could be supplying the more-demanded medium maturities.
This question speaks to an ancient issue in debt funding - the trade-off between opportunistically supplying whatever‘s in demand on the one hand, versus a fixed calendar of auctions on the other. The DMO has been following the latter policy - hence today’s problem. The argument for doing this is that it reduces the risk market-makers face; if these know what supply is coming, they can run their books accordingly, and this reduces the risk premium in gilts and hence funding costs for the tax-payer.
But it could well be that the size of debt issues required, plus QE, mean that this policy should change, and the DMO should have more flexibility to issue as and when it can.
Whatever, markets are not spooked. Yes, some cash prices fell, especially at the longer end. But the June long gilt future has had a decent day in the end. Whose opinion would you trust - that of informed traders, or the semi-literate commenters on some blog?
I fear, however, that the truth is rather more mundane.
The thing is, gilts are in normal times near-substitutes for each other: 2049 stock is very similar to 2048 stock, which is similar to 2047 stock and so forth. However, quantitative easing has changed this. The Bank will buy gilts (pdf) in the 5-25 year range. Ceteris paribus, this gives gilts in the 2014-34 year maturity range a liquidity premium over other issues.
Now, in principle this new premium should have been embedded in prices immediately, when the policy was announced earlier this month.
However, because QE is a new policy, we can’t be sure how a big this premium should be. All that’s happened with this auction is that we’ve discovered that it should be bigger than the market thought yesterday. It’s just part of the price discovery process.
You might wonder why the DMO is issuing long-dated gilts at all, when it could be supplying the more-demanded medium maturities.
This question speaks to an ancient issue in debt funding - the trade-off between opportunistically supplying whatever‘s in demand on the one hand, versus a fixed calendar of auctions on the other. The DMO has been following the latter policy - hence today’s problem. The argument for doing this is that it reduces the risk market-makers face; if these know what supply is coming, they can run their books accordingly, and this reduces the risk premium in gilts and hence funding costs for the tax-payer.
But it could well be that the size of debt issues required, plus QE, mean that this policy should change, and the DMO should have more flexibility to issue as and when it can.
Whatever, markets are not spooked. Yes, some cash prices fell, especially at the longer end. But the June long gilt future has had a decent day in the end. Whose opinion would you trust - that of informed traders, or the semi-literate commenters on some blog?
"Whose opinion would you trust - that of informed traders, or the semi-literate commenters on some blog?"
Well, either is likely to do better than a highly trained macroeconomist, eh?
Posted by: dearieme | March 25, 2009 at 04:53 PM
There's also a clue in the BBC coverage:
"The UK Treasury has failed to sell all its government bonds in an auction for the first time since 2002."
Of course, we all remember the great financial crash of 2002...
Posted by: Tom Freeman | March 25, 2009 at 08:49 PM
Axctually, its either complete incompetence or a dastardly right wing plot.
Personally, I favour the incompetence theory
Posted by: kinglear | March 26, 2009 at 09:54 AM
"The financial end is not nigh". Do you mean that in the same sense that our currency moving from $2 to $1.35 in six months did not constitute a run on the pound?
Posted by: kardinal birkutzki | March 26, 2009 at 02:09 PM
The Guardian reports that today’s sale received £2.98bn bids for £1.1bn of gilts.
xD.
http://www.guardian.co.uk/business/2009/mar/26/gilt-sale-succeeds
Posted by: Dave Cole | March 26, 2009 at 02:43 PM
wait until you need wheel barrows of cash to buy a loaf of bread. then panic.
Posted by: Cyber Rainbow | June 15, 2009 at 01:24 AM