I missed this headline a couple of days ago in the FT:
They added:
All those who now suggest that people would not want to save in the Green New Deal bonds that Colin Hines and I have promoted have this uncomfortable evidence that there is massive demand f0r green savings products to contend with.
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We could have issued £100 billion of 12 year gilts with a fixed coupon of 0.875%. I think that is slightly lower than “normal” 12 year gilts. And they are planning a 20 to 30 year “green” gilt too.
Remind me again: if issuing gilts to the market remains a good idea, rather than relying on QE, why we are not locking in the current very low interest rates? Why even bother with index-linked gilts at the moment?
All excellent points
There were bids for £100bn – but we don’t know at what price. We do know that the highest £10bn were at 0.87% but we don’t know where £20bn of £50bn would have cleared the market.
Should the BoE issue more long dated gilts and stop Index Linked gilts?
The UK already has the longest maturity debt profile of any country and it is getting slightly longer as issuance is tilted towards the long end. Should it be longer still? Perhaps.
Should they stop issuing Index linked gilts? No. First, there are investors that need this paper and they expect a regular supply. Second, what message would it send about the government’s commitment to low inflation? It could send serious shock waves through the market. Third, from an asset-liability perspective, tax revenues are (to some extent) index linked so it makes sense to have index linked liabilities. Fourth, they are issued by auction (like other gilts) so, in theory should have the same expected cost.
We know that the syndication of 7/8% (0.875%) gilts due 2033 sold at a slight premium: £100.03.
https://www.dmo.gov.uk/responsibilities/green-gilts/
https://www.dmo.gov.uk/data/datareport?reportCode=D10A
Who know what the results might have been at £20bn or £50bn, but with a ten times oversubscription there seems to be considerable appetite for more.
The government needs to issue index linked gilts because investors need it? How kind of the government to offer this service.
Can you explain why it is a good idea to make sure that liabilities in respect of index linked gilts rise in proportion with receipts from tax revenues? What benefit does the government derive from linking its interest payments to inflation?
Clive
I thin k many will be interested in this explanation
Richard
In addition, the Green Gilt trades at a lower yield that a conventional gilt (2.5bp lower). This is the clearest demonstration that investors WILL sacrifice returns in order to pay for climate initiatives.
As you have frequently observed, there is always money to do what we want (either created or borrowed)… the real issue is do we have the resources (mainly skilled people) to do what is required?
That is the real question now
Or perhaps it’s more a case of dirty money looking for a place to get laundered? Goverment bonds are gold to money launderers. This might explain the massive over-subscription. Check out “The Laundrymen” by Jeffrey Robinson, an eye-opening read.
You do know who most likely applied, don’t you?
I think your comment makes almost no sense
How so? Money laundering is not a thing?
You know it is
So do I
But not through this type of bid process from approved market makers I suggest
Looking at Andrew’s post, I thought the idea of Green Gilts was that the funds would go to GREEN climate environmental energy saving projects not aircraft carriers, HS2 etc. I also thought that it was not that easy to control the social, environmental effects of QE, so I’d have thought that Green Gilts were best for the climate. I’ll go back and read your posts on QE and refresh my memory. Remember I’m an very old bird living in the woods of Canada, fairly well educated, and probably somewhat representative.
I’ll have to check what the Bank of Canada is up to. I haven’t heard of green bonds in Canadian media but they, the B of C have a website which is quite informative.
Really like your blog. I sent you piece on THE MULTIPLIER to the NDP Jagmeet Singh for the recent election. I hope he read it!
Thanks
The headline information that £100bn of demand was chasing £10bn of supply certainly sounds promising.
It’s a worry though that there is only £10bn of supply, which presumably indicates that there are considerable difficulties in defining if an earmarked investment by government meets green criteria.
No, the problem is a lack of will to do green activity
No “reply” button below Andrew’s comment……. so here is my reply below. (part 1)
The key message from this auction is that Green gilts were sold at a more expensive level than conventional gilts, investors will give up return in order to finance green projects.
My secondary point was that we should not read too much into the amount (£100bn) of interest.
Government bonds are typically issued by auction and I would almost completely disregard the volume of bids as an indicator as to the success or otherwise. It is too easy to stick a few massive “throw away bids” well below the market level that will boost this number without any real intention to buy. For regular auctions the key number (apart from where it trades relative to other gilts) is the “tail” – the difference between the average accepted bid and the lowest accepted bid.
Non government bonds are usually done via “syndication”. A Syndicate of banks intermediate a negotiation between borrower and investors to establish where the bond can be sold. They start with “price talk” which gives a range of where the bond will be priced (relative to some benchmark bond). After feedback from investors they will firm this up to give a single spread versus the benchmark bonds and then take orders. Everyone wants the deal to go well so typically the pricing is made slightly attractive to where one might expect which means that there are lots of buyers. Indeed, potential buyers know they will be scaled back when bonds are allocated so they bid for far more than they really want. Once this happens things snowball and speculators put in massive bids in the hope of a small allocation that they can flip out at a small profit straight after the issue starts to trade in the secondary market.
This can lead to some fun and games! If the borrower sees all this demand they might choose to tighten the pricing or increase the size of the issue. But, if they do this, then the bidders have to be asked “are you still in?” with the new sizing/pricing… and if you push too far then you might get the answer “NO”. It is a delicate balance to get the “feel good factor” in the launch without leaving too much on the table for the speculators/investors.
On rare occasions Governments do syndicated deals – particularly if it is a new product like this. Here, the price talk was +7.5/8.5bp versus the 4.25% 2032 for £10bn. There was strong demand so it priced at +7.5bp with £100bn interest. The book runner then allocated bonds to investors (how this allocation is done is another story in its own right and possibly a scandal yet to come!). The total number of bids was about 200 making the mean bid size about £500mm (!). I would guess there were a few hedge funds that put in bids for billions in the hope of getting £5 million or £10 million.
Of course, the DMO could have increased the size or tightened the price in response to this demand but this would have run the risk that the buyers stepped away. What was important was that the deal was a success and that it traded well in the secondary market…. allowing future issues at tight pricing.
Thanks
No “reply” button below Andrew’s comment……. so here is my reply below. (part 2)
With regard to Index linked gilt issuance…. and apologies for mixing MMT/traditional thinking…..
YES issuing gilts IS a service that the government kindly offers – MMT says there is no requirement to issue gilts other than part of its actions to control inflation. So, if you are going to offer a service then you might as well do it properly and deliver what the client wants.
Also, clients will pay more for what they want so even in a non-MMT world where governments are trying to cover deficits with the least interest cost it still makes sense to issue Index Linked gilts. Nobody knows the long term prospects for inflation but long dated real yields are about -2% versus conventional yields of 1% (very rough numbers and great care needed in imputing too much from them) so this means that IF the government meets its long term inflation target of 2% over the next 40 years that IL gilts will cost zero (versus conventionals at 1%). In short, investors are paying a hefty price for inflation protection.
In the early 90s the RBNZ did a lot of work trying to work out the optimum mix of their debt portfolio. If you view interest rate expense as just another cost in your overall budget it makes sense to have that cost rise and fall in line with your tax revenue…. as it will give a less volatile budget deficit number. Tax is quite closely linked with nominal GDP so the idea was to have debt that costs more only when nominal GDP is rising strongly. This would suggest a decent chunk of inflation linked bonds but also some foreign currency borrowing (as a devaluation would boost GDP) and a shorter maturity profile than one might expect (as short term rates and GDP are linked).
I am not sure I wholly buy into this approach but I do think Index Linked Gilts have a place in the Government debt portfolio.
Thanks again
Thanks indeed. Helpful to see this laid out.
Having tested the water in the green gilt space, I’m pretty sure we’ll see much more of it next year.
The fact that investors are willing to pay the government so much for inflation protection implies quite strongly that investors don’t think the government will hit inflation targets consistently for 40 years, and at some level the investors think the protection is worth the cost. They are probably right: it would be a miracle to fully control inflation for that long.
But, apart from a larger up front premium, what benefit does the government (indeed the public sector) get from taking that risk away from the private sector? What is the benefit in artificially reducing the volatility of the budget deficit by voluntarily linking payments to receipts?
Long term inflation protection is always expensive as the risk is asymmetric. Hyper deflation is impossible… but hyper inflation, whilst unlikely, is possible… and the market votes with its feet.
On your second point, I think there are situations where government can bear risk better than individuals. whether this is one of them I am not sure… but we are in a world where IL gilts are issued and changing the status quo would carry risks.
Why reduce budget deficit volatility? Why indeed! Unfortunately, not all are as enlightened as you and still live with the legacy of “Maastricht deficit criteria”, “Brown’s Golden Rule”, “US Balanced budget legislation” etc.. So, if the deficit is viewed as an important target number, volatility in interest costs would imply random volatility in what is left to be spent on important stuff. Nonsense? Yes…… but it still holds sway in some quarters.
I entirely agree that there are many costs and risks that the government (that is, the nation, the whole population) will be better able to bear than individuals.
It is not clear to me why that means those who can afford to buy index linked gilts get state protection from inflation – in essence, socialising the risk that inflation might erode their income and assets.
I can see a political or presentational advantage to the governing party in being able to smooth budget deficits, so one year does not look unusually good compared to another that is unusually bad (perhaps a post-COVID 2021-22 or 2022-23, compared to the pandemic hit 2020-21) . But that involves a cost that potentially falls on everyone, in the sense that resources might be directed at servicing the gilts which could have been directed at something else. Perhaps it is naive to think so, but it seems to me that issuing index linked gilts makes more sense if you think the rates might fall, but not if they can only rise.
But this is wide of the original point – which is the strong demand for “green” gilts, notwithstanding the slightly lower return they may carry compare to “normal” gilts.
I have to admit that I have always shared this sentiment