On the go: The value of UK Treasuries has fallen sharply after the fiscal statement on September 23, which announced a raft of unfunded tax cuts for businesses and high earners as well as homebuyers.
The yield on the 10-year UK government bond had reached 4.1 per cent by 11.22am on September 26, up 0.3 percentage points, following a surge to 3.7 per cent by lunchtime on the same day, wiping value off the bonds as buyers expected more interest rate rises amid increased borrowing by the government.
The government announced a swathe of tax cuts in the mini-Budget, including abolishing the 45p higher income tax rate and cutting the basic rate by 1p in the pound from April 2023. It will also cut stamp duty and create low-tax options for businesses.
The previous government’s 1.25 percentage point increase in national insurance for both businesses and taxpayers has also been reversed.
At the same time as effectively cutting its revenue, the government confirmed its energy support package, including a price guarantee for both households and businesses, will cost £60bn in the first six months alone.
Much of this is unfunded and will need to be financed through issuing gilts.
According to the Financial Times, the UK Debt Management Office increased its planned bond sales for the 2022-23 fiscal year by £62.4bn to £193.9bn.
The higher UK government yields are, the more expensive it will be for the government to borrow money.
However, there could be a positive outcome for defined benefit schemes, said Barnett Waddingham partner Ian Mills.
“The effect of rising gilt yields will be significant — DB pension scheme liabilities will have fallen sharply in just a couple of days, perhaps by as much as 10 per cent for some schemes,” he said.
Many schemes will find that their funding positions have improved sharply, particularly those that have not fully hedged their interest rate and inflation risks, and that for many this will present opportunities to derisk, Mills added..
XPS Pensions’ chief investment officer, Simeon Willis, shares this view. He said: “The unprecedented surge in gilt yields [on September 26] on top of those seen [on September 23] will have improved UK pension scheme funding levels by a greater quantum than a whole year’s deficit removal contributions.
“Market conditions are changing at pace and the factors that influence them stretch far beyond the pensions industry.”
However, DB schemes using liability-driven investments will come under pressure, especially if the rise in yields is sustained, Mills added.
“The rise in gilt yields will likely cause schemes to have to recapitalise hedges — some will be able to do so from cash reserves, but others will find they are forced to sell other assets,” he said.
“Some schemes could even be forced to unwind hedges exposing them to the risk of reversals in yields.”
Willis concurred, adding that he is starting to see LDI managers “flag new emergency collateral calls, a trend that is likely to continue in the coming days”.
“Agility is key, and schemes should be braced as we move to a new market environment,” he said.
“Without fail, schemes using LDI should review their plans and assess whether further action is required to maintain a diverse portfolio, be ready for any further LDI collateral calls, and maintain — or even increase — hedging to lock in these improvements.”
This article first appeared on FTAdviser.com
