With Wednesday’s confirmation of the amount of issuance expected via the Debt Management Office through 2010 alone, these funds need to face up to the reality that UK debt has moved a step close to being downgraded – with all the implications that holds for investors, such as changes to yield curves.
Greece, Mexico and Ireland have already been downgraded this year on the basis of poor debt/GDP ratios coupled with ongoing fiscal deficits.
Ireland announced a 20 per cent cut to the wage of the country’s prime minister yesterday as part of swingeing public sector cuts in its latest fiscal moves. The country’s debt rating was last cut by S&P in June with a warning on the country’s outlook. Greece is stumbling towards 'junk' status according to some reports on the country’s political crisis this week.
The massive growth in UK debt - according to the PBR figures,the public sector will borrow up to £789bn through to fiscal 2014-15 – takes place even as growth in the private sector is hit by higher taxation levels.
The key question is just who is going to buy this additional debt: Quantitative Easing (QE) by the Bank of England is set to cease in the first quarter of 2010.
QE works by buying up treasuries in the market to inject liquidity into the financial system. With liquidity freed up - some point to the massive improvement in the stock market since the spring as evidence of where this new easy money has gone – there is no monetary reason for the Bank to keep QE in place. But that throws the burden back on to fiscal policy makers.
The challenge will be to find buyers of the new debt at a price that does not make it an unviable exercise.
Thirteen funds with exposure to gilts over 1-yr
Source: Financial Express Analytics (data to 9 December 2009)
Risk vs performance for 1-yr (to 30 November 2009)
Source: Financial Express Analytics
Schroders fixed income manager Warren Hyland has commented that there could be a big problem for the Debt Management Office (DMO) to find buyers of gilts. "The DMO needs to issue a massive amount of gilts, with QE expected to finish at the end of January we can not see a natural buyer at current yields," he says.
The PBR has suggested the debt to GDP ratio could go from 56 per cent in 2009 up to 78.1 per cent by 2014.
"The Fitch debt/GDP ratio should fall from 2011 onwards to be consistent with the AAA rating, clearly not the case. The IMF has forecast debt/GDP to be 98.3 per cent in 2014."
"Overall the budget was negative for gilts – too much debt to issue," Hyland continues. "We expect the curve to steepen and rates to rise [which is] negative for sovereign ratings. Fitch has recently downgraded Mexico (debt/GDP 47.9 per cent) and Greece."
Royal London Asset Management's economist Ian Kernohan says: "Unless a deficit reduction programme is deemed credible by the rating agencies, the UK's sovereign rating will come under question, which will push up gilt yields and the cost of debt servicing, making the problem worse."