Hedging UK Government Risk

OldScientist

https://forums.moneysavingexpert.com/discussion/comment/82151522#Comment_82151522

Auctions over the last year or so (https://www.dmo.gov.uk/data/gilt-market/ ) appear to have had bid-to-cover ratios of over 3 (with the exception of the 1 1/8% ILG 2036 which had a cover ratio of 2.99) - this means that each auction was oversubscribed. The time to worry is when that number falls below 2.0 (I note that November 2022 was 1.89 - I wonder what caused that!). AFAIK, it is not easy to find out who is actually bidding.

A foreign investor would need to weigh up the slight yield premium (e.g., at 10 years, 5.5% compared to 5.0% for the US) with any concerns about changes in exchanges rates, their own local inflation, and the possibility of default compared to holding other fixed income.

StewedApple

Auctions over the last year or so (https://www.dmo.gov.uk/data/gilt-market/ ) appear to have had bid-to-cover ratios of over 3 (with the exception of the 1 1/8% ILG 2036 which had a cover ratio of 2.99) - this means that each auction was oversubscribed. The time to worry is when that number falls below 2.0 (I note that November 2022 was 1.89 - I wonder what caused that!). AFAIK, it is not easy to find out who is actually bidding.

Although the downloadable data set has about 1200 rows (auctions) and about 400 have a ratio of <2%. Which suggests c1/3rd do not meet this level. The dates within that cover the whole gamut of political and economic events - both domestic UK and World e.g. Iraq War / 2008 Banking Crisis etc.

I have no doubt bond markets are a significant issue for any Chancellor, but it is a complex picture.

Albermarle

https://forums.moneysavingexpert.com/discussion/comment/82152435#Comment_82152435

I have no doubt bond markets are a significant issue for any Chancellor, but it is a complex picture.

AIUI, the domestic demand for UK gilts has declined, due I think to the decline of DB pensions. So we rely more on foreign investors than we used to.

Linton

https://forums.moneysavingexpert.com/discussion/comment/82151522#Comment_82151522

Again you misunderstand how (inter)national economics works. UK companies buying foreigh goods dont take a pile of $s, Euros etc from a central national holding of foreign currency. Instead they buy the currency for £s on the global markets where major currencies can be readily traded.

The system is self correcting. Say the value of the £ drops against other countries due to foreigners losing confidence because of the trade balance. The result is that UK goods decrease in price for foreigners leading to an increase in UK exports. Conversely the price of foreign goods increases in the UK making locally produced items more desirable. So the country's imports decrease. Both effects lead to the balance being restored.

Foreigners dont lend us money out ot altruism. They buy UK gilts as a competitive and safe investment.

Finally there are currency movements which are not covered by the trade statistics. For example expenditure by foreign tourists and the depositing of foreign wealth by foreign individuals and foreign entities into the safety of the highly regarded London banking system.

Albermarle

into the safety of the highly regarded London banking system.

Or the very secure property market ( in legal ownership terms)

I think some people reading the media get the idea that the UK is some kind of feckless third world type country, on the verge of bankruptcy, banking collapse etc when it obviously is not like that at all.

Veloflyer

https://forums.moneysavingexpert.com/discussion/comment/82149992#Comment_82149992

Apologies. Lazy thinking by me - what I meant was HMG could default and BoE steps in to buy back the gilts - assuming they are not the same thing. As you state, the risk here is inflation - as presumably printing presses would be mobilized again, and perhaps doubly mobilized to print even more money as a means of paying for stuff HMG cannot presently afford.

Inflation would appear a bad thing to those on non-index linked gilts/bonds, to cash, and make the £ increasingly worthless. I guess my question is how to protect against a level of inflation which may rise far more than whatever the BoE says it is. ILGs for sure…anything else?

Linton

https://forums.moneysavingexpert.com/discussion/comment/82152787#Comment_82152787

HMG cant default, it doesnt have a ring fenced pot of gold. But never mind, the risk always is inflation. The theory AIUI is that Inflation is caused by excessive creation of money beyond the availability of goods to spend it on. It can be cured by increasing the supply of goods or reducing the amount of money in circulation, for example by taxation. By creating money to buy back bonds the BoE could be adding to inflation.

Inflation is calculated by the statisticians in the Office of National Statistics. Thinking that they will deliberately get it significantly wrong seems a bit paranoid.

To answer the question, other than ILGs, another way to protect against local UK inflation could be through investments in companies and bonds (and possibly other assets) across the world, on the basis that world wide inflation across all currencies would seem pretty unlikely. Other assets could include gold but it does not generate wealth.

michaels

https://forums.moneysavingexpert.com/discussion/comment/82152621#Comment_82152621

Exactly, if we want to buy things from abroad either we need to sell things of equal value or we need to borrow the difference. If borrowing the difference becomes impossible because no one wants to buy GBP assets because sterling is expected to continue falling then we have to very quickly go from a position where we consume a lot more than we produce and borrow to pay for the difference to one where we can only consume goods to the same value as those we produce. So basically an instant 3% fall in consumption would be required, or more if foreigners actively tried to divest UK assets rather than just refusing to purchase more.

The existence of the J-curve means that price adjustment is not instant and painless either but tends to move in the wrong direction initally.