UK eyes linkers as ultra-long demand spikes

06/27/2013

By John Geddie

LONDON, June 27 (IFR) - Buoyed by the success of its landmark 55-year Gilt on Tuesday, the UK looks set to capitalise on demand for its debt at higher yields by issuing a new ultra-long inflation-linked Gilt in September.

Robert Stheeman, chief executive of the UK Debt Management Office, said that while the recent yield hike had brought unwanted volatility to markets, it had also stimulated demand for ultra-long Gilts.

Nearly GBP12bn of orders were placed for the GBP5bn 3.5% 2068 issue on Tuesday, which offered a yield of 3.651%. At the beginning of last month, the UK's previous 50-year benchmark - a 2060 maturity - was yielding around 3%.

It is now hoped the upward trend in yields could help unlock further pockets of demand in the linker market.

"September could present an opportunity to issue a super-long index-linked deal. But we've not committed to that, and we want to wait and see how market demand evolves," said Stheeman.

"We are told there is potentially hundreds of billions worth of demand [in the linker market] that has not materialised as yet because of extraordinarily low yield levels, and the fact there have been negative real yields."

The DMO has already indicated it will reopen an index-linked Gilt in the 25-40yr maturity area in the second half of July, and then issue a new long-dated linker in the second half of September.

It now appears, however, that the DMO is erring towards the ultra-long end for the September syndication.

Minutes from the consultations on upcoming issuance last month show that the Gilt-Edged Market Makers (GEMMs) suggested September's issue should be in the 50-60yr area, while investors indicated a 55-60yr option.

HEALTHY BID

GEMMs reported secondary market demand for the 2060 conventional Gilt shot up when yields broke 3.6% last week. Accounts eager to lock in those yields became impatient for the forthcoming supply, and the demand had to be satisfied by the Street.

"That created a very healthy bid in the market for the new syndication, and as a result there were somewhat larger orders from market-makers," said Stheeman at the DMO.

But the demand from GEMMs was complemented by eager real money buying as well, said lead managers, allowing the new 2068 issue to price at the tight end of 3.5-4.5bp guidance over the 2060 Gilt.

"There was definitely a lot of interest from the GEMMs, but this was probably the strongest real money interest I have seen for a Gilt deal to date," said Myles Clarke, co-head of global syndicate at RBS, one of the banks managing the 2068 sale alongside Barclays, Lloyds and Nomura.

The big unknown, however, is how indicative demand for nominal paper is for inflation-linked products, which have a captive but narrower investor base in pension funds looking to hedge their liabilities.

"There is no question that the fundamental demand [for linkers] is there, but you cannot underestimate how much impact volatility can have," said Clarke at RBS.

"It will be interesting to see whether the move upwards in yields over the last couple of weeks will bring in more inflation-linked hedging activity going forward," added Stheeman at the DMO.

On an outright basis, inflation-linked bonds certainly look more attractive than they did a month ago, but yields have risen a lot less than they have in the nominal Gilt market.

Since the start of last month, the yield on the UK's 2062 Gilt ILB has risen by around 30bp, but the 2060 nominal Gilt yield has increased by double that over the same time frame.



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