# UK Bonds Issue?



## trajan (14 Oct 2022)

On BBC News TV Channel this morning I happened on something that is absurd - at least to my ears. 

The story goes thus:

UK budget promises tax cuts with no solid basis for funding public expenditure holes resulting from them. The bond market fears default in gilts so the price of these falls following selling by institutions holding a lot of them. This means that buyers of the sold gilts are getting a higher intetest return on these bonds. Now (here is my disconnect) this is said to be creating a problem for the UK government . . . 

Where's the additional problem for the UK government due to this, since the cost of the bond coupon remains the same and the eventual repayment of say a £100 bond will be unchanged? 

Is it because higher rates available in the gilts trade siphons away funds from competing financial markets and these are forced to up their rates in response to the new market conditions ? 

Please excuse my macroeconomic innocence as I am but a humble rustic bumpkin engineer.


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## joe sod (14 Oct 2022)

I think it's more that the interest rates on new issue bonds for the British government rises therefore making it more expensive for them to finance everything since they are supposedly cutting taxes.
Because you can get higher interest rates on new issue bonds the price of existing bonds must fall to equalise interest rates. Just shows now how daft it was to invest in negative interest rate bonds during covid, I wouldn't like to be waiting around for a century to get my money back on those 100year Austrian government bonds at 1%. Now we have 10% inflation!!!


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## trajan (14 Oct 2022)

That is fine.
But the noise is about interest rates for borrowers, variable mortgage holders and so on.
So commercial banks therefore are following an interest rate increase begun in the public sector - as they must as their applied rate is constructed on the so-called base rate.

So, if this is all eminently predictable to those schooled in macroeconomics, why have they done what they've done ?


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## MrViking (15 Oct 2022)

We’ll be asking ourselves the same question after Sinn Fein get into power! Same reason.


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## MrViking (15 Oct 2022)

BTW, has anybody noticed how SF has dialled down the rhetoric around capping energy prices for consumers since the disastrous UK situation?


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## jpd (15 Oct 2022)

if the bond markets can frighten a country as big as the UK, frightening a country as small as Ireland will be chicken feed - get ready to welcome back the Troika


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## cremeegg (15 Oct 2022)

trajan said:


> This means that buyers of the sold gilts are getting a higher intetest return on these bonds. Now (here is my disconnect) this is said to be creating a problem for the UK government . . .
> 
> Where's the additional problem for the UK government due to this, since the cost of the bond coupon remains the same and the eventual repayment of say a £100 bond will be unchanged?


So far no problem.



trajan said:


> Is it because higher rates available in the gilts trade siphons away funds from competing financial markets and these are forced to up their rates in response to the new market conditions ?


Yes, although this is slightly further down the road and a problem for the UK economy as a whole rather than specifically a problem for the government.

A more direct problem for the UK government is that any new debt or old debt being refinanced will be at the new rates.


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## cremeegg (15 Oct 2022)

trajan said:


> So, if this is all eminently predictable to those schooled in macroeconomics, why have they done what they've done ?


Truss and others in the UK government believe that growing the economy reduces the debt burden in relative terms. Arithmetically this is true, and apart from environmental concerns this has long been considered a sound policy objective.

They also believe that the best way to achieve growth is by reducing taxes, especially on the wealth generating sectors of the economy. This idea has a lot of support among economists generally, though it does rather depend on where the economy is starting from, are taxes too high to begin with ? will tax cuts drive inflation ? are there other constraints on growth ?

The market wants to see the overall plan. If taxes are cut where will the money to run the country come from. From increased tax revenue (due to the growing economy even though tax levels are lower). Through borrowing. Or through cuts to public spending.

Governments rarely make fiscal decisions without outlining their overall plan like this. Kwarteng said he would publish his plan in November, subsequently revised to end of Oct. In the UK they have the Office of Budget Responsibility which 'provide independent and authoritative analysis of the UK’s public finances'. Kwarteng didn't show them his plan either.

UK corporation tax rates are high, UK personal tax rates are not low. The UK govt approach may not have been the best approach to the issues in their economy but it was not unreasonable. The problem is that the markets think Truss and Kwarteng had no plan and were just making it up as they went along.

Because of all this, when the plan is eventually published in whatever form it has by then, it will receive a much more critical scrutiny, than it might  have if they had just said day 1,  We are cutting taxes, We are growing the economy, We are not concerned about inflation, We may borrow short term to finance public services, but growth will take care of that.

I think that there will be a further lurch downward for the UK when this plan is actually published. No matter what changes they make in the meantime.


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## cremeegg (15 Oct 2022)

jpd said:


> if the bond markets can frighten a country as big as the UK, frightening a country as small as Ireland will be chicken feed - get ready to welcome back the Troika


If only we pooled our currency with part of a bigger block. That might have the strength to withstand bond market jitters.


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## jpd (15 Oct 2022)

Yes, using the euro will help, but EU will not bail us out without conditions - à la 2008, Greece, etc etc


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## trajan (15 Oct 2022)

@cremeegg  Thanks for low-down. Though stated like that I wonder why Truss and Kwasi didn't just blurt it all out.
But Ireland's issues pertain more to a government impeding new housing than our treasury situation.
That is the primary inflation component over the last 6 years and in my view is the hidden hand in a lot of our recent "Ukrainian inflation".
Does the recent higher cost of diesel for Castletownbere trawlers cause the recent doubling in fresh fish prices ?
I think not. To me it's the fishermen - and everybody and anybody between us and them - availing of this excuse to award income increases to themselves - increases they can morally justify because of continually increasing house and rent prices.


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## Jim2007 (15 Oct 2022)

jpd said:


> if the bond markets can frighten a country as big as the UK, frightening a country as small as Ireland will be chicken feed - get ready to welcome back the Troika


Nonsense., it has nothing to do with the size of the economy.  It has to do with confidence and ability to pay back.  Ireland never had an insolvency problem, it has a liquidity problem as evidenced by its ability to pay down borrowing since 2007.  The country has produce positive balances of trade for decades and that makes all the difference, because as Swiss bankers say - if you are selling more that you are buying you will eventually work your wait out ant financial difficulties.  All through the last crisis we advised Swiss clients to continue and increase their investment in Irish bonds based on this simple analysis and they did very well out of it.  And today the SNB holds a large block of Irish bonds as part of its reserve.  The future is never the same as the past and you need to move on.


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## cremeegg (15 Oct 2022)

trajan said:


> But Ireland's issues pertain more to a government impeding new housing than our treasury situation.


I agree that housing is Irelands biggest issue, from a social as well as an economic perspective.

It is a problem of success, the number of people at work in Ireland has increased considerable since the end of the pandemic. Infrastructure especially housing has not kept up.

I am not sure that government actually impedes new housing, but it has certainly failed to support housing enough.


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## joe sod (15 Oct 2022)

Jim2007 said:


> Nonsense., it has nothing to do with the size of the economy. It has to do with confidence and ability to pay back. Ireland never had an insolvency problem, it has a liquidity problem as evidenced by its ability to pay down borrowing since 2007.


But what about 2010, the markets didn't believe  that Ireland had a liquidity  problem  but an insolvency  problem that's why the interest rates on Irish  government bonds rocketed   then and Ireland had to go to the IMF to bail itself out as the bond markets effectively  would not lend to Ireland . Yes the treasury management  agency  has managed the Irish government  debt very effectively  by managing  to refinance a lot of it at very low interest rates  before the latest big rises in interest rates. But we shouldn't  get overly complacent or smug about the problems the UK is facing right now, we have a much higher per capita debt load than the UK and among the highest in Europe .
The buyers of the bond issues during covid in Irish debt are now down in money due to rising interest rates and falling bond prices. Also the Irish balance of payments surplus is highly dependant  on a few US multinationals that are now facing their own issues with rising interest rates and profit warnings the latest from Intel and Novartis


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## NoRegretsCoyote (15 Oct 2022)

trajan said:


> Please excuse my macroeconomic innocence as I am but a humble rustic bumpkin engineer.


The way to think about government bonds is that there are huge amounts of them outstanding, being traded all the time, but new issuance is very small. Ballpark 1% of total outstanding government debt is paid back and issued again every month. That's not very much.

So the _immediate_ impact of rising rates on the outstanding debt is very little. The government still pays the coupon in line with the rate when the bond was issued, the government only pays more interest on new issuance.

However the impact of high rates can spread through the stock of debt over the course of a number of years. When you model this you model less money for government to spend which means more taxes, probably less growth, and less tax to service debt from. Debt dynamics are interesting - it depends on a lot of things but debt at 90% of GDP can mean that everyone will lend to you confident that they'll get their money back, whereas debt at 100% of GDP can mean that no one will lend to you confident that they will get their money back.  Herding can be very strong - when everyone else is you will feel safe to do so, and when no one is investing you won't feel safe to do so. So some of this explains the big market swings visible over the last month.

FWIW I don't think the UK will in any meaningful way default. It issues all debt in its own currency so the worst that can happen to investors is inflation. They will still get their money back in sterling, it just might not have the purchasing power it once did.


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## trajan (15 Oct 2022)

NoRegretsCoyote said:


> FWIW I don't think the UK will in any meaningful way default. It issues all debt in its own currency so the worst that can happen to investors is inflation. They will still get their money back in sterling, it just might not have the purchasing power it once did.



Interesting.
But taking borrowers on their own currency is riskier and would be offset by a higher rate surely.
I see no risk of a default either - policies would be changed and elegant excuses made.
The Humphrey Applebys would see that's done at least


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## joe sod (15 Oct 2022)

NoRegretsCoyote said:


> However the impact of high rates can spread through the stock of debt over the course of a number of years. When you model this you model less money for government to specnd which means more taxes, probably less growth, and less tax to service debt from.


You forgot to mention cuts in government  spending, we had to do that during the eighties  and during the bailout, it wasn't  a choice either remember,people  won't pay large increases in taxation  unless they see cuts in government  spending as well, they vote with their feet and leave the country those that are young and skilled anyways.

1% a month on total government  debt to be repaid every month  is still 12% a year , so 3 years on the effect of high interest rates are going to be felt, because this era  of  high inflation  and high interest  rates still has a long way to run. There are shortages in the energy markets that will take many years and huge amounts of investment  to address,Ireland  hasn't built a new power station in a decade.  The state  could be hit with the bill for all this as well, because the private  sector no longer wants to do it


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## MrViking (16 Oct 2022)

Final salary pension schemes have been a major purchaser of gilts for many years. It has worked well for the UK government, as an issuer of debt as there has been plenty of willing buyers (demand) to keep yields low. The major problem now is that UK final salary schemes are  almost fully hedged and demand from this key historical buyer of UK debt has gone past peak and is in decline. Increasing gilt yields has accelerated this drop in demand. So the big question is, without these pension funds, who is going to purchase the extra supply of gilts…..in an environment where even more supply is likely coming on stream?? The situation here is going to get a lot worse, and yields will rise next week. Unless the chancellor can significantly reign in spending, expect a s*it-show by Christmas.


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## joe sod (16 Oct 2022)

But it's not just a UK problem it's universal, the acuteness is being felt in the UK now but everyone that has a pension is going to be hit by falling bond prices. Complacency crept in among pension providers that bond prices would rise to compensate for falling stock markets therefore they could safely invest in bonds . Now bond prices are falling along with stock markets so pensions are getting a double whammy, first time this has happened since 1970s. 
Low risk pensions meant that pension providers just loaded up on bonds instead of stocks, that worked since the 80s but no more, now pensions are loaded with some of that horrible negative yielding bonds they bought during covid and before.


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## trajan (16 Oct 2022)

"Almost fully hedged" pension funds ?
Till now I'd thought hedge funds were only a way of laying off risks from conventional market trading - side-betting on periodic collapses in all shares, etc.
But it seems they are the wideboys of the financial markets: short-selling, arbitrage, etc.
Boys, oh boys.
The UK bond market brought to crisis through aggressive trading by fund managers for the nation's pensioners'.
And for themselves, of course.


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## MrViking (16 Oct 2022)

trajan said:


> "Almost fully hedged" pension funds ?
> Till now I'd thought hedge funds were only a way of laying off risks from conventional market trading - side-betting on periodic collapses in all shares, etc.
> But it seems they are the wideboys of the financial markets: short-selling, arbitrage, etc.
> Boys, oh boys.
> ...


Sorry Trajan…..I should have explained a bit more. “Hedged” has nothing to do with hedge funds. It’s a technical term which actually means the opposite to taking risk….as it relates to removing risk in these DB funds…..by ensuring that movements in long term interest rates dont negatively or positively impact on the funding position (or solvency) of the plans. So it’s a good thing for plan members


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## trajan (16 Oct 2022)

But:
1. It seems from online browsing that many pension funds **do** invest in hedge funds, as well as conventional bond, share and unit trusts.
2. The hedging process you allude to must come at the cost of reducing more traditional ways of securing a secure pension income, e.g. moving investment from shares and UTs to government bonds as the beneficiary approaches retirement age and loses the time to re-grow his/her nest-egg through market resurgence.

Everyone should take an autumn course in their local tech on pension fund dynamics.


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## joe sod (17 Oct 2022)

Most pension funds not just in the UK but worldwide are loaded with very low yielding bonds from the last decade. Those bonds are now worth alot less due to rising interest rates and falling bond prices. Therefore all pension funds are suffering and will continue to suffer from falling bond values.
It's a mistake to think that this is just a UK only problem caused by Liz truss policies, it's not. Liz truss just crystallized the losses in pension funds and caused panic. The game is to allow people to slowly acclimatize to falling pension values and allow pension providers to offload the negative yielding stuff  they bought before when everything was great for bonds in the never ending pantomime of falling and negative yielding bonds. It must be remembered that pension funds were obligated by government regulations to buy these government bonds therefore ensuring a reliable funding source for governments . This resulted in a feedback loop causing interest rates to fall alot further than they really should have. The real world has come back again with a bang and high inflation is here for a long time to come


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## trajan (17 Oct 2022)

_Most pension funds not just in the UK but worldwide are loaded with very low yielding bonds from the last decade. Those bonds are now worth a lot less due to rising interest rates and falling bond prices. Therefore all pension funds are suffering and will continue to suffer from falling bond values._

Doesn't the nominal redemption value remains the same and the annual coupon likewise ?
Yet I can see how a fund manager can't sell these now and move money to better stuff.

_It must be remembered that pension funds were obligated by government regulations to buy these government bonds therefore ensuring a reliable funding source for governments . . ._

Is that obligation still extant in Ireland, UK and EU - I mean as a legally binding obligation (e.g. a condition of a fund licence from the local regulator), not as a moral one ?


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## Purple (18 Oct 2022)

jpd said:


> Yes, using the euro will help, but EU will not bail us out without conditions - à la 2008, Greece, etc etc


Hopefully. It's a pity they ever left.


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## joe sod (20 Oct 2022)

"Which brings us to my second point. Recent turmoil in the UK draws attention to the fragility of markets for government debt around the world when they are not, one way or another, being manipulated by governments and central banks. Putting it bluntly, the world in the 15 years since the financial crisis is a world in which the authorities have artificially suppressed the yields on their debt. This is a big reason why bond yields haven’t risen anything like as much as inflation."

An extract from article from bloomberg explaining what is happening and that the problems are not confined to the UK. The main point is that interest rates have artificially been repressed by central banks globally.  Therefore when central banks or governments do something not in support of this the bond markets panic. Its not just a UK issue


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## joe sod (4 Nov 2022)

Yesterday we had the grim news that the UK is about to have its worst recession in years and treasury raised interest rates again by a record amount.
Yet the markets loved it and the stock markets rallied !!
What a strange world we are now living in where bad news is actually good news.
It appears that inflation is now the big issue and any news that is taking demand out of the market and thereby reducing inflation is taken as good news.
This is certainly different to the 1970s , but it's not a UK phenomenon, its global. 
Too much money was printed during Covid and supply of goods is now the restriction , not money or demand


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## Purple (4 Nov 2022)

joe sod said:


> This is certainly different to the 1970s , but it's not a UK phenomenon, its global.


Yea, in the 1970's global debt was around 100% of global GDP. Now global debt is 350% of global GDP.


joe sod said:


> Too much money was printed during Covid and supply of goods is now the restriction , not money or demand


We've been artificially depressing the cost of debt for over a decade, we've been kicking the can down the road. We're running out of road.


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