What the gilt market's saying

Duncan points out that the rise in gilt yields in recent weeks has matched those of major overseas bonds. He says:

The moves in UK gilt yields over the past weeks, months and even years tell us almost nothing about the prospect of default and the markets’ views on the Government. The Tories can scaremonger and moan all they like, but they are at best wrong and at worst dishonest.

He’s entirely correct - though I’m a little depressed that such a point even needs to be made. The UK has for years been a small open economy whose asset prices, bonds and shares, are driven mostly by overseas forces.
My chart just amplifies his main point (click on it to embiggen). It shows the spread between 10 year gilt yields and their US and German equivalents.
You can see that these spreads have recently narrowed. Indeed, as of yesterday’s close, 10 year gilts yielded less than their US counterparts - something which hasn’t happened since late 2006. Both spreads are well below their post-1999 average.
This means that investors actually regard gilts now as unusually safe, relative to foreign bonds. They require a smaller than usual risk premium to compensate for holding them. Markets, then, have more faith in UK government debt (relative to overseas debt) than they have usually had over the last 10 years.
Let’s be clear what this means. It means markets don’t think the UK government is much more likely to default than the US or German government - though, granted, CDS rates are slightly higher for UK government debt than US or German debt. And it means they don’t think out debt will lead to inflation, or to a run on the pound. Any of these would cause spreads to be high. Which they are not.
This doesn’t mean they have confidence in the government. Maybe Osborne is right that yields are low because markets are confident a Tory government will reduce debt. Or maybe few people have faith in policy at all and it’s just that for everyone who’s scared of inflation (which would raise yields) there’s someone else scared of depression, which would reduce yields.
The bottom line, though, is that Duncan’s main point is right. Scaremongering about UK government debt is not shared by the markets. Of course, it’s possible that markets are wrong. But let’s be clear. Such concerns are, for now, deeply out-of-consensus.

Comments

[Mark Wadsworth]

What do the spreads have to do with it, part from expectations of future interest rate changes/inflation?

Of course the UK is not going to nominally default on sovereign debt, it will just try and inflate it away, as they've done so many times before.

What is important is whether interest rates as a whole are going up or down. I'm convinced they're going to continue going up (but perhaps I'm wrong).

[John]

Chris, this is all interesting but I don't think you can say "investors think" or "the market expects" and have it mean anything when the biggest purchaser of UK gilts is the Bank of England, using printed money.

For as long as one branch of government is a purchaser of last resort in the market for the debt of another part of government, yields tell you what politicians want yields to be, not what the market thinks they ought to be.

[Sam Langfield]

John says: "...when the biggest purchaser of UK gilts is the Bank of England, using printed money"

Hardly. There are £713bn of gilts outstanding. The Bank of England has purchased, say, less than £100bn (I don't have the precise figure).

http://www.dmo.gov.uk/reportView.aspx?rptCode=D5E&rptName=46918827&reportpage=Market_Size

[John]

Sam come on. There's a difference between being the biggest purchaser of something and being the biggest owner of something.

The US is the biggest purchaser of oil, but it owns a tiny proportion of the 'oil outstanding' - that's mostly underground in the middle east.

Let's assume your figures are correct - I have no reason to believe they aren't -£713bn of gilts outstanding, and £100bn or so purchased by the Bank of England over a period of six months or so.

There are about 25 million houses in the UK. If I were to buy them at the same rate as the Bank of England is buying available gilts, I would have to buy 290,000 houses a month.

What do you think that would do to the price of houses, and therefore to the yield on a rental property?

[dsquared]

Chris, you can't just subtract one government bond yield from another and call it a credit spread - they're in different currencies. You need to do this chart based on the UK's dollar Eurobonds.

[Guido Fawkes]

Chris.

Can you deal with the point made above that the BoE is the biggest buyer of Gilts, suppressing yields.

What happens when that stops?

The Fed is basically playing this game as well.

[Bob B]

Is this really grim news if the UK economy was being boosted by the weak exchange rate for Sterling?

"Sterling has reached its highest level against the euro since the start of the year after data suggested the UK recession may be over."
http://news.bbc.co.uk/1/hi/business/8094729.stm

[Bob B]

Sterling is not only appreciating against the Euro. According to this in The Economist, it seems the change in stockmarket prices in Britain over the last 12 months hasn't done nearly as badly compared with the change in stock prices in other leading stockmarkets around the world:
http://www.economist.com/markets/indicators/displaystory.cfm?story_id=13832379

Are the political doom sayers trying to lead us up the garden path?

[rockinred]

Oh dear."Embiggen". I do hope this is a joke. You may be an economist, but not even that excuses illiteracy.

[air jordans]

A man is not old as long as he is seeking something. A man is not old until regrets take the place of dreams.

[nike dunks]

It is a wonderful article,i like it,thank you very much!

[Ed hardy clothes]

Many http://www.ed-hardy-clothing.co.uk ed hardy shirtsdesigns are more or less the same with each other.

[buy products wholesale]

This is my web site http://www.poloshirtsshop.com,who are interested, you are welcome to look at.

[ed hardy]

I tried to think so, but i found it was not as the same in the actual

process. As you mentioned, I still have doubts, but really thank you

for sharing!