Pimco, one of the world’s largest bond investors, is giving UK government debt a wide berth, reflecting concerns that a post-election borrowing binge promised by all the major political parties could add to pressure on prices.
Andrew Balls, Pimco’s chief investment officer for global fixed income, said the measly yields on offer from gilts already makes them one of Pimco’s “least favourite” markets. The prospect of increased sales of gilts to fund more government spending makes the current high prices even less attractive, he said, forecasting that the cost of UK government borrowing would rise.
“Gilt yields look too low in general. If you don’t need to own them it makes sense to be underweight,” he told the Financial Times.
The coming election could bring the biggest boost to public spending since the mid-1960s. The Conservatives are promising to use low interest rates to finance “an infrastructure revolution”, the Liberal Democrats are seeking a £100bn capital investment increase, and Labour is planning to substantially increase the amount of money it would borrow for capital spending in its first term if elected.
Labour’s 2017 promise to borrow £250bn over 10 years for a new National Transformation Fund will now expand by adding £150bn over the first five years — taking the fund up to at least £400bn after a decade with much of the spending front-loaded.
Labour would increase net capital investment from £47bn this financial year to more than £100bn a year, using the extra borrowing to invest in transport, energy, housing, education and the NHS in what would be the biggest boost in public sector investment since the 1970s.
“If you do have a big increase in supply you would expect that to feed through to higher yields, but the key issue will be the impact on growth,” Mr Balls said. “The devil’s in the detail in terms of what they spend the fiscal boost on.”
Pimco’s warnings echo its view in 2010 when founder Bill Gross said UK sovereign debt was resting “on a bed of nitroglycerine” thanks to shaky government finances. That forecast failed to materialise despite a decade of high public borrowing.
The cost of financing UK government debt has been rising over the past month. The 10-year gilt yield has reached 0.76 per cent, from 0.42 per cent in early October. That remains unattractive compared with the 1.84 per cent yield available on the equivalent US government bond, according to Mr Balls, who is the brother of former Labour shadow chancellor Ed.
One factor pushing up UK yields recently has been a global pullback in bond prices. At the same time, Prime Minister Boris Johnson’s success in sealing a new Brexit deal last month prompted investors to scrap their bets on a chaotic departure from the EU, which they wagered would boost gilts by forcing the Bank of England to cut interest rates.
Pimco, which holds more than $1.8tn in assets, currently has a substantially smaller allocation to gilts than their representation in bond benchmarks.
Mr Balls did, however, suggest there was a limit to the rise in borrowing costs, which will reassure politicians that they are not promising big increases in borrowing just as the market turns. He said there were powerful forces acting against an explosive sell-off and a spike in yields.
With more than $13tn of bonds — mostly in Japan and the eurozone — trading with negative yields, a sharp rise in gilt yields would draw in buyers, he said.
“There’s the gravitational pull of Europe and Japan which drags down global yields,” he said. “That makes it an environment in which governments will be tempted to borrow and spend without fearing an attack of the bond vigilantes.”
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