Last week, the Financial Times ran an article bemoaning a dearth of opportunities in the government bond markets. Quantitative easing (QE) and zero interest rate policy has sat heavily on the market and discouraged volatility, but has also quashed any expectations of change any time soon. It is strange that this response to the vast supply of government bonds we see today is the same as it was to having no supply of government bonds over twenty years ago.
Back then, in 1999 and 2000, the UK’s public finances were in rude health. Debt was being repaid as a booming economy, 3G auction receipts and balanced public spending swelled coffers. The concern was of a trajectory showing the government would have no debt in twenty years’ time – what were we to do without any government debt? What a difference a financial and public health crisis can make to public finances.
The current concern over a dearth of opportunities stems from the fact that in the UK, all the incremental supply to support the Covid-19 response has been funded by the Bank of England, thanks to QE. This is similar to other major countries’ policy response. But as we learnt twenty years ago, the trajectory of today’s expectations rarely comes to pass and projecting today’s extreme of expectations may prove foolhardy. There are plenty of opportunities ahead: the prospect of negative rates, future higher inflation, geopolitical turmoil or trade wars; or simply the upcoming US elections and the UK’s exit from Europe. Whilst many of these may lead to uncomfortable outcomes, they will not lead to a dearth of opportunity.
None of this is to say that material volatility in government bond markets is imminent, but rather expectations of no volatility are exaggerated. Expectations will differ for those who look at Japanese government bonds (JGBs) or Italian government bonds (BTPs). For the UK, upcoming net supply is set to be priced by the market rather than solely the Bank of England – and Andrew Bailey has suggested the future unwind of current policies starts with selling back government bonds to the market rather than raising interest rates. Given the Bank of England has £700bn-odd of Gilts available, there will be opportunities ahead.