Gilts Lost Their Shine in December After Pound Hit Mini-Peak
Recent figures from the Bank of England (BOE) showed a sharp decline in Gilt purchases by foreign investors in December, which was probably a function of the stronger Pound.
Foreign buyers tend to be put off buying Gilts when Sterling is stronger because they get less ‘Gilt’ for their money.
Likewise, when the Pound is weak overseas investors flock to snap up gilts because they get more for their money.
Pound Sterling peaked at 1.18 versus the Euro at the start of December after the lows plumbed in the post-party conference flash crash in October, and this may explain why Gilt purchases dropped off so much in December.
A note from ING shows how buying was much stronger in October and November when a cumulative 26bn in Gilts was purchased by foreign investors compared to December’s meagre 2.97bn.
It is possible that investors saw the perfect time to bottom-feed on Gilts when Sterling was at all-time lows in October.
Brexit and Other Considerations
The fall in demand for Gilts may go beyond pure exchange rate mechanics however argues ING’s Viraj Patel.
Brexit fears have reduced demand for Gilts because of concerns a hard-Brexit could lower the perceived creditworthiness of the UK government, leading to a fall in the Gilt market.
Nevertheless, even this may not be the whole story.
“While naturally, investors may associate the selling of UK assets with increased hard-Brexit fears, we are wary of reading too much into one month's data. Our Debt Strategy Team note that there was a broader selling of core developed market sovereign debt at the end of last year, making the UK gilt story less of an anomaly,” says Patel.
Indeed, the rising global reflationary economic environment is having a dampening effect on sovereign debt markets all over the world – the UK included.
'Idiosyncratic' Risk To Weigh on Sterling
Regardless of where Gilts go ING see the pound as vulnerable to a sell-off in the light of increasing political risk.
They note how pressures will rise in the run up to the date the government has put aside for the triggering of Article 50, March 9,” though we think a lot of cards need to fall in place for this to occur (note the House of Lords are scheduled to hold its vote on Mar 7)," writes Patel.
ING’s base case is that opposition party attempts to slow the passage of the Brexit Bill through parliament will actually weaken the Pound, even though it could also be argued that such a sequence of events could also strengthen Sterling due to the intent to achieve a “Softer" Brexit.
ING target the 1.2430 level in GBP/USD as a result of Sterling weakness, although this could also be reached if US data or the Fed statement on February 1 is particularly hawkish.
As for the Euro to Pound, Patel says, “EUR/GBP pierced through the 0.8600 handle and we would expect some near-term consolidation around here (100-dma comes in at 0.8656).”
