Bond Yields Long term

Pat38493

Can someone help me understand how the news headlines about this are calculated?

We are seeing UK government 30 year bond yields at the record level since 1993 of 5.6% (source BBC) today.

However what does this actually mean?  I don't think the government issues 30 years bonds every day that you can buy, so is this based on market trading of the existing 30 years bonds in circulation today i.e. this is what the market currently thinks the yield should be?

leosayer

The yields are a pure mathematical calculation based the market price of each gilt, the maturity date and the coupon (interest) rate.

The price is set by the market ie. based on supply and demand from market participants like pension funds, fund managers, private individuals etc. 

Secret2ndAccount

The global opinion is that Britain is slightly more likely to go belly up within 30 years. Therefore some people who are already in posession of 30 yr bonds decide to sell them. Not a ton of buyers about, so they have to drop the price. Therefore the live price today of existing bonds is lower. If you buy them and hold to maturity, you still get the same fixed amount back. Therefore the yield is slightly better - you get the same return for a lower purchase price, or more return from the same amount spent.

Pat38493

Secret2ndAccount said:

The global opinion is that Britain is slightly more likely to go belly up within 30 years. Therefore some people who are already in posession of 30 yr bonds decide to sell them. Not a ton of buyers about, so they have to drop the price. Therefore the live price today of existing bonds is lower. If you buy them and hold to maturity, you still get the same fixed amount back. Therefore the yield is slightly better - you get the same return for a lower purchase price, or more return from the same amount spent.

So this doesn’t actually cost the government any money as such, yet.

It’s only if the government issues 30 year bonds and they can only sell them at this coupon price that the actual price of government debt to the taxpayer went up?

(Unless a lot of these bonds are held by the government themselves in a kind of circular ponzi loop?).

Secret2ndAccount

The Bank of England holds quite a lot of government bonds:
TR54 pays out in Oct 2054. BofE owns £10 billion
TR4Q pays out in Dec 2055. BofE owns £10 billion
T52:  £12 billion

Means there is less money in the bank. Means it's time to take some action to shore things up, or it will get worse. You don't want the next tranche of bonds that we auction off to go for knockdown prices. The money we pay to service that debt would be better spent on schools and missiles.
American yields up today as well. The bond traders are just seeing a less stable landscape right now. Could all turn out to be nothing, or it could be the start of something. We don't want to be the lame one at the back of the herd if the predators start prowling.

MarkCarnage

UK needs to get a grip on this. 
Historically, long dated gilts had a captive market from Defined Benefit pension schemes, primarily for regulatory reasons. Now, as schemes are better funded and more mature, they are offloading their risk to insurers, who do not have the same regulatory regime, and less need to hold long dated gilts. 
Additionally BoE are still in the process of Quantitative Tightening - selling gilts. 
That's the technical market side of things (not all of it but some key bits). Can manage that to a degree by issuing shorter dated gilts, which is what has been happening. 
However, the UK also has a significant long dated index linked gilt market, and persistently high inflation is costly here too. 
Ultimately, we are dependent on the kindness of strangers (not a good place to be) unless we cut spending or raise taxes. 

OldScientist

Pat38493 said:

Secret2ndAccount said:

The global opinion is that Britain is slightly more likely to go belly up within 30 years. Therefore some people who are already in posession of 30 yr bonds decide to sell them. Not a ton of buyers about, so they have to drop the price. Therefore the live price today of existing bonds is lower. If you buy them and hold to maturity, you still get the same fixed amount back. Therefore the yield is slightly better - you get the same return for a lower purchase price, or more return from the same amount spent.

So this doesn’t actually cost the government any money as such, yet.

It’s only if the government issues 30 year bonds and they can only sell them at this coupon price that the actual price of government debt to the taxpayer went up?

(Unless a lot of these bonds are held by the government themselves in a kind of circular ponzi loop?).

No not yet. In the past, governments have sometimes shortened the maturity of the bonds issued (or reduced the amount issued for longer bonds) during periods of high yields (e.g., the 1970s and 1980s) and, in the UK, even issued gilts with a 3% coupon (despite the rates being much higher than this) because they had lower yields (because gilts are and were exempt from capital gains tax). With the latter, I assume someone in the treasury calculated the difference in lost income tax (from coupons) and the lower price at which they were issued and saw a gain to be made.

On the other hand, for inflation linked gilts, the recent period of high inflation will have now increased the cost of coupon payments.

leosayer

Aside from fiscal, monetary policy and currency implications of such high yields, surely current conditions present a opportunity for those in or approaching retirement with no debt?

Why take the risk of holding a high allocation to equities for future retirement spending when the risk-free rate is 5%+ and annuities offer ever more compelling rates?

Cus

Isn't the 5% just an indication that inflation expectations are at that level? So you lock in 5% but everything costs 5% more every year. When the risk free rate was 2% then everything went up 2% a year. I guess the equity allocation may provide more than inflation, whatever it is.

Secret2ndAccount

Cus said:

Isn't the 5% just an indication that inflation expectations are at that level? So you lock in 5% but everything costs 5% more every year. When the risk free rate was 2% then everything went up 2% a year. I guess the equity allocation may provide more than inflation, whatever it is.

No. 30 year Index Linked gilts are paying about 2.5% while conventional gilts are at 5.5%. So the market's guess at future inflation is 3%.  The rest is a return on investment - payment for getting to use your money for 30 years.

Pat38493

Secret2ndAccount said:

Cus said:

Isn't the 5% just an indication that inflation expectations are at that level? So you lock in 5% but everything costs 5% more every year. When the risk free rate was 2% then everything went up 2% a year. I guess the equity allocation may provide more than inflation, whatever it is.

No. 30 year Index Linked gilts are paying about 2.5% while conventional gilts are at 5.5%. So the market's guess at future inflation is 3%.  The rest is a return on investment - payment for getting to use your money for 30 years.

So I could put say £200K into those 30 years gilts, and I would receive £11K per year for 30 years, and then I would get the capital back at the end (albeit at the nominal value)?