UK Bond Vigilantes Send Reeves a Reminder of What They’re Watching – BNN Bloomberg

(Bloomberg) — As U.K. Chancellor Rachel Reeves wrapped up her key budget speech, bond traders seemed pleased.

But within minutes of Reeves’ speech to the British Parliament, aimed at demonstrating tight control over the country’s finances while finding money for investment, the benchmark 10-year bond erased its rally and turned to losses.

The abrupt moves underscored the tightrope the new government must walk as it tries to keep debt investors onside and dispel memories of former prime minister Liz Truss’s disastrous 2022 mini-budget.

Although a Labor government’s first budget in almost 15 years was well-publicized and contained few surprises, government bonds turned higher after a pair of accompanying reports predicted a larger-than-expected volume in debt auctions and predicted a cut in Bank of England interest rates . cuts.

“There’s not much room for error,” said Neil Mehta, portfolio manager at Bluebay Asset Management. “Could this unleash bond vigilantes? Yes.”

How little room for maneuver there was was visible.

Trek forecast

The Debt Management Office first said it would issue 297 billion pounds of government bonds in the 2024-25 financial year, topping the 293 billion pounds estimate from 16 bond dealers in a Bloomberg survey.

Then, in its Economic and Financial Outlook report published on Wednesday, the Office for Budget Responsibility upgraded its forecast for the Bank of England’s key rate and gold yields. Market participants were unlikely to have anticipated the full extent of discretionary budget easing, according to a report released shortly after Reeves finished her speech.

This was enough to alarm bond investors.

“This is the loosest budget we’ve had in many, many years,” said Ales Kutny, Vanguard’s head of international rates. “We don’t think this will lead to massive action from the Bank of England, but it’s not a dovish signal.”

Busting Debts

Signs of nervousness were evident in the bond market in the days leading up to Wednesday’s budget presentation. Concerns about the extent to which the government might loosen borrowing rules have raised fears that there could be a sharp increase in debt in the near future.

British bonds sold off, pushing the benchmark 10-year yield to its highest level since June, while its spread to German peers approached 200 basis points, the highest in more than a year.

However, many investors increased their holdings of British bonds ahead of the announcement, and after the budget announcement, fund managers including BlackRock Inc., Abrdn Investment Management Ltd., Neuberger Berman and Federated Hermes remained indifferent to the moves, confident that volatility will soon subside.

The risk premium assigned to government bonds “looks stretched and has ample room to increase further,” said Tim Graf, head of EMEA macro strategy at State Street Global Markets. “Overall this looks like a more responsible budget, which we hope should generate some credibility in the market.”

Ultimately, the decline in equity prices slowed as the day progressed on Wednesday. The 10-year yield ended slightly lower after trading in its widest range since March 2023.

Strategists say they will be watching the Bank of England meeting next week to see whether the central bank’s economic outlook matches those from the Office for Budget Responsibility.

“The chancellor is trying to make clear to markets that there is runway to further support growth, but it will be used wisely,” said Vivek Paul, chief UK investment strategist at BlackRock Investment Institute.

“The gold yield response was nowhere near the 2022 situation.”

–With assistance from Alice Gledhill, James Hirai and Naomi Tajitsu.