Has "smart money" been selling gilts?
Simon Ward
2 Comments
Since its buying programme began in March, the Bank of England has swallowed up more gilts than the Debt Management Office (DMO) has issued. So which sector of the market has reduced its holdings?
The table, derived from Bank of England and DMO data, shows issuance and transactions by sector between March and October, with the prior eight months included for comparison. The Bank's buying exceeded DMO net sales by £26 billion in the latest eight months. The counterpart was a £24 billion decline in holdings of the "non-bank private sector". The combined holdings of overseas investors, banks and building societies were little changed.
The non-bank private sector comprises households, non-financial companies, insurance companies and pension funds, and other financial institutions. A monthly breakdown is not available but quarterly figures show that insurers and pension funds bought £12 billion of gilts between April and September, non-financial corporate holdings were little changed while households and other financial institutions sold £6 billion and £35 billion respectively.
The other financial category includes unit and investment trusts, other fund managers, including hedge funds, and securities dealers. Limited further information is available but the recent sales are likely to have been dominated by hedge funds and dealers.
These other financial firms have successfully traded the gilt market in recent years. They were heavy buyers before and during the financial crisis, boosting their holdings from £45 billion at the start of 2006 to £137 billion by the end of 2008. The 10-year benchmark yield averaged 4.7% over this period.
They started to unload their position in the first quarter of 2009 as the Bank began buying. Sales accelerated during the second and third quarters, when the 10-year yield averaged 3.7%. Their holdings had fallen to £96 billion by the end of September.
Gilt market optimists argue that the ending of the Bank's buying programme will be offset by stepped-up demand from insurance companies, pension funds and banks. Inflows to insurers and pension funds, however, have been weak while their liquidity ratio has fallen significantly – see chart. Banks' need to increase their holdings of liquid assets, meanwhile, has been satisfied recently by a rise in their reserve balances at the Bank of England – see memo line in table.
| Change in gilt holdings £ billion | ||
| July 2008 | March 2009 | |
| - February 2009 | - October 2009 | |
| Non-bank private sector | 31 | -24 |
| Overseas | 31 | 1 |
| Banks | 38 | -7 |
| Building societies | 3 | 5 |
| Bank of England | 3 | 171 |
| Total | 106 | 144 |
| DMO sales | 107 | 166 |
| Redemptions | 1 | 21 |
| Sales net of redemptions | 106 | 145 |
| Memo | ||
| Change in banks' balances with BoE | 2 | 110 |
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Reader Comments (2)
Simon, it seems to me that the BoE and DMO have rigged the gilt market for the last 10 months through the QE scheme. Even though the Maastricht Treaty forbids signed-up governments financing their debt by printing money, GoBro has worked around the law by backdoor trickery. The apparent “new issues” of £200bn gilt, meant to cover government deficit, went nowhere. All this money is now in the economy in the form of cash and reserve balances – the same result as a blatant money printing policy akin to Mugabe's Zimbabwe. I'd say there's no way the BoE can unload their gilt stockpile back to the market in the next 10, maybe 20 years. The MPC and BoE are intent on sucking in some of this money over-supply by issuing BoE bills (more commissions for the boys in braces!). Money Supply drifts further into uncharted waters.
After a year with no genuine buyers in the gilt market, next month the DMO has to find some, and at record levels (£200bn plus a year). Those who dumped their gilt holdings last year should soon be able to buy them back with a profit.
The first £125 billion of QE was justified on the basis that "money printing" was needed to offset "money destruction" caused by contracting bank balance sheets. With the banking system clearly stabilised by last summer, however, the further QE expansions announced in August and November were questionable and, by keeping gilt yields comfortably low, may have contributed to the government's decision to postpone fiscal tightening. Sales of bills by the Bank of England do not reverse QE - in particular, they have no contractionary impact on the M4 money supply. Bills will be auctioned so there will be no commission windfall.