UK - Increasing appetite for UK government inflation-linked debt by pension funds has caused Watson Wyatt to question whether the level of issuance can satisfy the demand.
In a research paper The Bond Market Yield Crunch, the firm discusses whether the growing level of UK government linkers during the past three years, and that planned for the next two, is high enough.
New nominal issuance of UK government inflation-linked debt has only been about £17bn in total for the past three years, with another £18bn (market value) of issuance expected for 2006 and 2007.
The comments come as the Debt Management Office today announced the auction of £2.5bn of 50-year gilts (4.5% Treasury Gilt 2055).
Nick Horsfall, senior investment consultant at Watson Wyatt, said: “This supply squeeze means the sterling inflation-linked bond market simply cannot accommodate a very large move into bonds by pension funds in the short term. As a result, it is likely yields will remain at current levels, with the potential for further falls depending on how quickly institutions continue to move into the market.”
Commenting on the UK government’s 50-year issuance, Jon Cunliffe, head of interest rate alpha at ABN AMRO Asset Management, said: “Long term nominal and real yields have risen over recent weeks reflecting trends in international bond markets and this, in conjunction with the undoubted strength of pension fund demand for long dated gilts should ensure that the auction is a success.
Watson Wyatt’s research paper suggests many pension funds face a dilemma in deciding between the benefits of de-risking by increasing their inflation-linked bond allocation and the risks currently faced from the mismatch of assets and liabilities.
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