Gilt yields have edged up in response to the announcements made on spending and borrowing by the chancellor. What should pension trustees do, and is a repeat of 2022 possible?  

The government is set to borrow an extra £32bn a year to finance spending commitments of £70bn, Rachel Reeves revealed in her Autumn Budget on Wednesday. This borrowing spree means the Debt Management Office’s Net Financing Requirement for 2024-25 is rising by £22.2bn to the staggering sum of £299.9bn. There will be additional gilt sales of £19.2bn – mainly long-dated – taking planned total gilt sales in 2024-25 to £296.9bn. The DMO is also making net cash sales of £3bn in Treasury bills for debt management purposes, up from zero.  

Gilt investors have reacted to the gilt issuance, with yields ticking up and reaching 4.46% for a 10-year gilt on Friday morning, falling back slightly since. Do pension funds have to worry there could be similar effects o their hedging arrangements as there were after the 2022 ‘mini Budget’?  

Nick Prouvost, a professional trustee speaking in a personal capacity, said the change in yield of 30bps at 10-year nominal and 19bps at 30-year nominal after the Budget “seems relatively minor” given the scale of borrowing that has been announced.  

Nonetheless, he advised trustees to keep a close eye on rising yields.  

For schemes making use of liability-driven investments for interest rate hedging, he expects this change in yield will have a minimal impact on their funding position, but said trustees should make sure their scheme’s collateral pool is “healthy” and the process for topping it up streamlined.   

“These are lessons that most across the industry have learnt the hard way following the gilts crisis, and so I expect the vast majority of hedged schemes will be in a safe place,” he noted.   

For schemes that are still unhedged, the rise in yields will mean a slightly improved funding position, he added.   

However, another way to look at it is “to learn a lesson about the volatility of gilt yields, if such a lesson still remains unlearnt”, he said, which is that just as rates can shoot up, they could come down equally quickly.   

“It is difficult to put in place a journey plan to a long-term objective if interest rate risk remains unhedged, as changes in yields could potentially drive the funding position more than any other factor,” he added.

For Ian Mills, head of DB endgame strategy at consultancy Barnett Waddingham, the rise in gilt yields after the Budget was no surprise. As well as being influenced by supply, demand for gilts will tend to be affected by considerations around inflation and growth, he said. 

 

Gilt buyers will want a higher yield for any greater expected real-terms devaluation of their capital through inflation, and similarly if growth is expected to be higher, because other investments become more attractive relative to gilts.  

The Office for Budget Responsibility said the government's extra spending “temporarily boosts GDP growth to 2 per cent in 2026, but leaves output unchanged in the medium term”. It expects inflation to rise slightly this year and next before falling back to around the 2% CPI target. 

 

Regardless of the rise in yields, another problem could arise. “The big question, however, is who is going to buy all these gilts?” said Mills. 

 

For the past two decades, UK defined benefit schemes were buying gilts “at almost any price”, he said, but they are now well funded and maturing, often targeting buyout, and “own pretty much all the gilts they will ever want to buy”.  

 

“The danger for the Treasury here is that when a DB scheme buys out most of those gilts ultimately are sold,” he argued, either by the scheme to pay a cash premium or by the insurer as it moves the money into higher yielding investments.  

 

“This could apply further upward pressure on yields from declining pension scheme demand over the next few years. Our view is that this will be felt most keenly in the long-end of the curve and especially in the index-linked market, where there are few other natural buyers,” he added. 

 

 

In addition to the Budget effect, there are the ongoing pressures on gilt yields. The Bank of England is unwinding its quantitative easing programme at a rate of £100bn a year, remarked Marc Devereaux, head of investment consulting at Broadstone. 

 

“It feels like a situation that could get worse, but currently the Budget doesn’t appear to have increased yields on a very dramatic scale yet, which of course, would be more concerning,” Devereaux said. 

  

“Schemes should continue to monitor hedging levels, ensure they have clear collateral support in place – we may see cash calls resulting from higher yields – rebalance asset allocation where appropriate, and consider opportunities to derisk where funding levels have benefited from the increase in yields,” he advised.  

 

So is the increase in gilts issuance currently a bigger problem for the Treasury than for pension schemes? Mills thinks a repeat of the 2022 gilts market crisis is unlikely, citing three differences with the circumstances two years ago – the involvement of the OBR providing certainty to investors, no rise in yields in the months before the Budget, and the better liquidity levels among schemes in response to 2022. 

 

   

How do you expect gilt markets to develop?