John Hamilton, manager of the Jupiter Corporate Bond Fund, comments on the recent failed auction of long-dated gilts.

Wednesday's auction of £1.75bn 2049 (40-year) gilts by the Debt Management Office was only 93% covered. Technically, that is a failed auction. 

Two other auctions of UK gilts have failed in the past decade. In 2002 an auction of £900m of 30 year inflation-proofed gilts was only 95% covered, while in 1999 an auction of £500m of inflation-proofed gilts was not fully subscribed to. The last failure of a non-indexed issue was in 1995. Falling tax revenues are forcing governments around the world to borrow in order to fund their spending plans. In Germany, two bund auctions have failed this year. The timing of the UK auction came a day after three unhelpful announcements.

First, Mervyn King, the Bank Governor, had uncharacteristically given the government a public warning about the dangers of any further fiscal stimulus. "Given how big these deficits are, I think it would be sensible to be cautious about going further in using discretionary measures to expand the size of those deficits," he told Parliament. Second, the same day, CPI inflation rose from 3% to 3.2% as a weaker pound led to higher (imported) food prices. This was much worse than the market's expectation of about 2.6% and caused a sell-off in gilts. Third, the gilt market was unnerved after Mervyn King indicated that the Bank of England might not use all of its authorised budget for quantitative easing. There is still a strong demand for long-dated gilts, but 40-year gilts are sensitive to inflation sentiment. The "failure" of the auction appears to be linked to volatility in the market on that day, with some uncertainty over the "going rate" such an issue should command.

The Debt Management Office was hived off from the Bank of England after the latter was granted independence. Not to have done so would have created an obvious conflict of interest where the boundary between fiscal and monetary policy become blurred. The recent introduction of quantitative easing inevitably risks a blurring of these two functions. While the Bank of England appears price-insensitive when purchasing gilts as part of its quantitative easing, pension funds and other institutions are not price insensitive. Our view is that pension funds thought the yield was not attractive enough and, since there would be plenty more issuance coming, they could afford to wait. The average yield on the take up was 4.5%. The failure of one gilt auction may be regarded as a misfortune but, in itself, is not greatly significant. The following day an auction for £1.1bn 2022 index-linked gilts was 2.72 times oversubscribed.

If however, the Debt Management Office experienced a series of auction failures then this could be interpreted as a warning signal from investors to the government that there is a clear limit to their willingness to fund future spending.

NOTE
Jupiter Unit Trust Managers Limited (JUTM) and Jupiter Asset Management Limited (JAM) are both authorised and regulated by the Financial Services Authority and their registered address is 1 Grosvenor Place London SW1X 7JJ. They are both subsidiaries of Jupiter Investment Management Group Limited and the group is collectively known as "Jupiter". The above commentary represents the views of the Fund Manager at the time of preparation and may be subject to change and this is particularly likely during periods of rapidly changing market circumstances. Their views are not necessarily those of Jupiter and should not be interpreted as investment advice. Every effort is made to ensure the accuracy of any information provided but no assurances or warranties are given. This is for investment professionals only.