Goldman, Amundi Like UK Bonds in Bet Reeves Averts Truss Moment
(Bloomberg) -- Goldman Sachs Group Inc. and Amundi SA are among those increasingly favoring UK bonds, an expression of confidence that the new government won’t jeopardize the country’s finances in its bid to spur the economy.
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Amundi has reduced exposure to European bonds to buy UK debt, while Goldman recommended clients buy gilts before Chancellor of the Exchequer Rachel Reeves unveils her debut budget on Oct. 30. BlackRock upgraded gilts to overweight from neutral and funds including Legal & General Investment Management Ltd and Aviva Investors have also been adding exposure.
The flow of money into gilts is a wager that Reeves will successfully manage to plug a ￡22 billion ($28.6 billion) hole in public accounts while also sourcing funds to improve public services. Markets are still scarred by Liz Truss’s disastrous “mini budget” of 2022 and the national debt continues to balloon.
“She will want to maintain some kind of perception of fiscal discipline,” said Daniel Loughney, head of fixed income at Mediolanum International Funds Ltd, who is overweight UK bonds.
The bet on UK bonds has been further bolstered by the view that the Bank of England will have to soon accelerate the pace of interest-rate cuts, which gained traction on Wednesday after data showed a sharp slowdown in inflation.
“The UK should benefit from slowing inflation and fiscal discipline,” wrote John O’Toole, head of multi-asset investment solutions at Amundi, Europe’s largest asset manager.
The new-found market confidence has emerged despite a month of losses for UK bonds. The 10-year UK yield has climbed more than 30 basis points since mid-September and is near the highest level in a year relative to US and German peers.
But Goldman strategists including George Cole said the gilt underperformance won’t last, and a “fairly gilt friendly” budget will allow bonds to bounce back.
The government is likely to use its first budget “as a set piece event to send a message of fiscal prudence,” BNP Paribas economists and strategists including Paul Hollingsworth and Camille de Courcel wrote in a note. This “could in fact unlock longs as uncertainty unwinds.”
Fiscal Rules
Markets expect Reeves to announce tax hikes and changes to self-imposed fiscal rules to allow for more borrowing. To avoid unnerving investors, she will have to reassure them that any new debt will go toward funding much-needed investments.
“We understand the concerns about moving fiscal goalposts, but unlike the Truss mini budget, we expect the Office for Budget Responsibility to be an important check on government plans,” said Sunil Krishnan, Aviva’s head of multi-asset funds.
One possibility is to tweak the calculation of national debt to exclude the BOE’s balance sheet, which could open room for an extra ￡16 billion in borrowing, according to Bloomberg calculations. A more drastic alternative, which offsets other debt liabilities, could free up to ￡67 billion, according to the Institute for Fiscal Studies.
“Fixed income markets are likely to balk at anywhere near to half of this sum given the impact of issuance on yields,” said Mark Dowding, chief investment officer at RBC BlueBay Asset Management, referring to the latter option. “That’s even if spending is targeted to invest into the economy.”
Citigroup Inc. economist Ben Nabarro earlier this month flagged the risk of a “buyers’ strike” if Reeves announces extra borrowing of around ￡50 billion next year. That’s because the market is already confronted with one of the largest bond supplies on record this year.
Still, bond investors trust Reeves will increase borrowing headroom only modestly to keep investors onside. Barclays Plc said she could be even more careful, waiting until 2025 to change the fiscal rules after a proper assessment.
“To have had one gilt crisis triggered by proposed fiscal expansion might be regarded as a misfortune but to have two will look like carelessness,” said Moyeen Islam, a rates strategist at Barclays who recommends buying gilts versus German bonds.
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