Gilt yields have risen since Labour’s £40bn tax-rising Budget, but pensions experts say this is unlikely to spark the same liquidity problems for DB schemes that occurred in the aftermath of Liz Truss’s 2022 ‘mini-Budget’.
Overall gilt yields are up by around 10bps today, following Rachel Reeves’s Budget yesterday — the first Labour Budget for 14 years. This is seen as a significant rise, although financial experts noted that yields were rising across Europe. However rises have been higher in the UK due to the Budget impact.
The 10 year yield is just off the 12-month high according to Barnett Waddingham.
Barnett Waddingham head of DB endgame strategy Ian Mills says “Following the Chancellor’s budget announcement yesterday, we have seen a steady rise in gilt yields. This has not been a surprise as the Chancellor indicated an intention to issue more gilts than previously expected by the market.”
He explains that supply and demand principles suggest that when supply increases this tends to push down prices. As yields and, as prices are inextricably and inversely related, yields are likely to rise as a result.
However, he says that while many will remember the fall out from the 2022 minute budget, when rising yields triggers a liquidity squeeze for many DB schemes following LDI strategies, there were key differences today, reducing the changes of similar repercussions.
He says the Chancellor involved the OBR in this process, so that investors have independent analysis of the impact of the budget on which to base their decisions. In 2022 the lack of this analysis led to an uncertainty premium feeding into yields.
In addition gilt yields had been rising significantly in the months preceding the 2022 budget, whereas this time they were not materially different to six months prior. In 2022 the rise in yields was already starting to squeeze some schemes’ liquidity even before the budget.
Mills adds that DB schemes and their asset managers have learnt their lesson from this previous problem and most had far far higher targeted levels of liquidity prior to this budget than they did in 2022.
Mills says: “The big question, however, is who is going to buy all these gilts? For the last twenty years or so UK DB schemes have been buying gilts at almost any price. They are, however, now generally very well-funded and own pretty much all the gilts they will ever want to buy.
“The danger for the Treasury here is that when a DB scheme buys-out most of those gilts ultimately are sold (either by the scheme to pay a cash premium) or by the insurer as they redeploy assets into higher-yielding investments. This could apply further upward pressure on yields from declining pension scheme demand over the next few years. Our view is that this will be felt most keenly in the long-end of the curve and especially in the index-linked market where there are few other natural buyers.”