Wednesday 14 March 2012

100year gilts not attractive - especially not at current yield levels


George Osborne wants to test the market for 100 year gilts. I can understand that issuing such paper at current yield levels would be great for the Treasury and UK taxpayers, but it is harder to understand why investors would want to risk locking into low rates like this.

Pension scheme durations are nearer 20 years than 100 years, so the suggestion that the Government is considering issuing ultra-long gilts may not find favour with many pension investors - especially not at current yield levels.

Following the Bank of England's massive gilt-buying programme, Government bond yields have been pushed to artificially low levels that fail to fully reflect UK economic fundamentals.  This means gilts may be attractive in the short-term but they carry greater risk once interest rates and bond markets return to more normal valuation criteria.

Of course regulatory requirements, accounting and actuarial constraints - as well as the desire to de-risk in the face of big deficits- all drive pension and insurance funds to hold more gilts, but what they really require is more long dated index linked paper or - even more interesting would be for the Chancellor to finally issue longevity gilts, which would help pension funds match their liabilities more directly and would potentially carry little or no coupon in the short term. 

Helping pension funds better cope with rising life expectancy would be a much safer way for the Government to raise funds and, if pension deficits keep mushrooming, ultimately the Government will carry the risk anyway.

In summary, 100 year bonds may be attractive to the Chancellor as some kind of macho symbol that the markets have great confidence in his stewardship of our economy, but it is far from clear that sensible long-term investors would pile in at current yield levels.

Or is the plan to get the Bank of England to buy them to try to bolster market sentiment about the UK!?


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