(Bloomberg) -- As UK Chancellor Rachel Reeves wound up her key budget speech, bond traders seemed content.
But within minutes of Reeves’ presentation to the UK Parliament — aimed at demonstrating a tight grip on the nation’s finances, while finding money to invest — benchmark 10-year gilts had erased their rally and flipped to losses.
The sharp moves underscored the tightrope walk the new government must perform as it tries to keep debt investors on side and dispel the memory of former Prime Minister Liz Truss’ disastrous mini-budget of 2022.
Even though the Labour government’s first budget in almost 15 years was well-telegraphed and contained virtually no surprises, gilts reversed gains after a pair of accompanying reports predicted a bigger-than-anticipated slate of debt auctions and forecast fewer Bank of England interest-rate cuts.
“There isn’t much room for error,” said Neil Mehta, a portfolio manager at Bluebay Asset Management. “Could it unleash bond vigilantes? Yes.”
Quite how little room to maneuver was on display.
Forecast Hike
First the Debt Management Office said it would issue £297 billion of government bonds in the fiscal year for 2024 to 2025, topping the £293 billion estimate from 16 bond dealers in a Bloomberg survey.
Then, in its economic and fiscal outlook report published Wednesday, the Office for Budget Responsibility raised its forecast for the Bank of England’s main rate and gilt yields. The full extent of discretionary fiscal easing in the budget is unlikely to have been anticipated by market participants, it said in the report, released soon after Reeves finished her speech.
That was enough to alarm bond investors.
“This is the loosest budget we’ve had in many, many years,” said Ales Koutny, head of international rates at Vanguard. “We don’t think this will lead to a massive move from the BOE, but it’s not a dovish signal.”
Debt Splurge
Signs of jumpiness were visible in the bond market in the days running up to the Wednesday’s budget. Concern over the extent to which the government might loosen borrowing rules had stirred fears a debt splurge could be in the offing.
UK bonds sold off, sending yields on benchmark 10-year gilts to the highest level since June, while their spread over German peers neared 200 basis points, the highest level in more than a year.
Still, many investors had boosted exposure to UK bonds ahead of the announcement and — in the wake of the budget — fund managers including BlackRock Inc, Abrdn Investment Management Ltd., Neuberger Berman and Federated Hermes remained unfazed by the moves, confident that the volatility will soon subside.
The risk premium assigned to gilts “looks overdone and has ample to scope to come out further,” said Tim Graf, head of EMEA macro strategy at State Street Global Markets. “It looks like a more responsible budget overall which should hopefully build some market credibility.”
Ultimately, Wednesday’s drop in Gilts eased as the day wore on. The 10-year yield ended the trading session slightly lower, after trading in its widest range since March 2023.
Strategists say they’ll be watching the BOE meeting next week to see if the central bank’s economic outlook chimes with that of the Office for Budget Responsibility.
“The Chancellor is trying to signal to markets that there is a runway to support growth further, but that this will be used judiciously,” said Vivek Paul, UK chief investment strategist at the BlackRock Investment Institute.
“The reaction in gilt yields was a far cry from the 2022 episode.”
--With assistance from Alice Gledhill, James Hirai and Naomi Tajitsu.
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