Relationship between gilts v PIBS/ Prefs

[Jwdool]

The last few trading days have seen a sharp increase in long end yields - from around 4.5-6 to >5%. PIBS and Prefs, however, appear to be relatively stable. It seems the market is now pricing PIBS/ Prefs more along the lines of 2 year gilts, as opposed to the longer end. Quite often we see a lag between pricing on long gilts and PIBS/Prefs - but this relationship appears to be breaking down.

I suspect this is a result of the changes in the cap stack rule - in particular on insurers (GACA/B, AV.A/B, RSAB) and the implicit intention of issuers to tender where possible (NATN/W, NWBD, BOI etc.).

I'd interested to hear views on the eroding relationship between long end gilts and PIBS/ Prefs.

[88V8]

I suspect this is a result of the changes in the cap stack rule - in particular on insurers (GACA/B, AV.A/B, RSAB) and the implicit intention of issuers to tender where possible (NATN/W, NWBD, BOI etc.).

Indeed.
I'm making what are for me large bets on the tender factor, been loading up on AV.A/B & GACA/B, altho not yet RSAB.
It's not entirely a short-term play as I'm largely an income investor, but just at the mo I'm likely also a small brick in a wall of distortive speculation, and tomorrow I will be adding to it.

V8

[Jwdool]

My concern with these names - is that at some point it will become too tempting to hold them relative to gilt risk. I suspect we'll start to see some serious dislocations if gilt yields top 5.5% on the long end, but stranger things have happened. If we see 6%, then I think we will get pretty close to the sort of structural economic problems faced by govt in 1989-91 - i.e. a meaningful reduction in aggregate demand and climbing unemployment. In that respect the cycle is self-correcting, if it is linked to inflation.

What I'm struggling to understand at the moment is the correlation between climbing gilt yields and the darkening economic data. It seems to me we've got ~18 months of interest rate tightening to come - which will bring with it declining macro data. We are not in the same position as the US, yet gilt yields appear to be tracking Treasuries. That looks wrong to me.

[GoSeigen]

The last few trading days have seen a sharp increase in long end yields - from around 4.5-6 to >5%. PIBS and Prefs, however, appear to be relatively stable. It seems the market is now pricing PIBS/ Prefs more along the lines of 2 year gilts, as opposed to the longer end. Quite often we see a lag between pricing on long gilts and PIBS/Prefs - but this relationship appears to be breaking down.

I suspect this is a result of the changes in the cap stack rule - in particular on insurers (GACA/B, AV.A/B, RSAB) and the implicit intention of issuers to tender where possible (NATN/W, NWBD, BOI etc.).

I'd interested to hear views on the eroding relationship between long end gilts and PIBS/ Prefs.

What exactly is the cap stack rule and how has it changed? It's not a term I'm familiar with.


As for price, is it not simply the the case that issuers of PIBS and preference shares are banks, which are raking in capital hand over fist, whereas gilts are issued by the UK government and monetised by the BoE; both gilts and money are suffering from a secular turning point in their fortunes?


GS

[Jwdool]

I'm using short hand (capital stack) for what counts as regulatory capital under Solvency II. This is quite an interesting paper on it, but on my reading preference shares won't count towards the required capital under the new regime which I understand comes into force at some point in 2026. See:

https://www.bankofengland.co.uk/-/media ... ps1020.pdf

The CET1 build up in most financials that have issued prefs/PIBS appear to be well over the requirements. This seems particularly so with building societies such as Skipton/ Coventry/ Leeds/ Newcastle etc. The PIBS now appear as Tier 2 - given the grandfathering regime for Tier 1 (CET1) availability ran out in April 2021. I think it is a matter of time before those notes are tendered. They are an expensive way to maintain non-reg cap - given the CET1 is supposed to be adequate for any loss absorption. From the handful of cases where PIBS coupons were suspended - they were largely restarted once CET1 requirements went over a particular hurdle (with some niche exceptions such as WBS).

As I said earlier, I think the break with PIBS/ Prefs gilt prices seems almost entirely down to the fact the market is pricing it off the 2 year and not the 30 year? But I'm happy to hear different views!

[Gan020]

I'd interested to hear views on the eroding relationship between long end gilts and PIBS/ Prefs.

I agree there is a disconnect atm.

I suggest the average retail investor who invests in PIBS/Prefs does not apply the same sort as logic to the process as yourself or an institution.

[OldBoyReturns]

I agree - the disconnect between long end gilt yields and perpetual PIBS & prefs yields is very unusual and hard to explain. A few months back I was expecting long end gilt yields would fall with yields of perps following with a lag. I was completely wrong and, instead, long end gilt yields have risen while the yields on perps have fallen. The spread of lower yielding bank perps is new less than 200bps above long end gilts.

I do not find the Solvency II explanation particularly compelling because it only relates to insurers and, even then, are still a few years out. The capital rules affecting bank prefs / PSBs & building societies PIBS have been fully implemented for at least a couple of years now.

Supply side factors may offer a partial explanation. There has certainly been a marked fall in pref, PSBs & PIBS yields since the Bank of Ireland tender offers completed - suggesting a wall of retail cash looking for a new home against a limited supply of perps. Whereas with gilts the BoE is actively dumping its massive holdings on the market and no amount of retail buying is going to make a dent in that.

It will be interesting to see whether more banks and building societies tender for their retail denomination prefs, PSBs and PSBS following on from recent tenders by Bank of Ireland, NatWest and Ulster Bank.

[dealtn]

What I'm struggling to understand at the moment is the correlation between climbing gilt yields and the darkening economic data.

What is wrong with darkening (whatever that is) economic data and rising long end gilt yields.

There are 2 processes at play here. 1) The long end is a (sort of) average of the short end policy rate over that time frame BUT 2) has a premium attached to it that covers other factors such as risk of default, necessary credit premium, duration risk.

Poor economic data can have a huge impact on the 2) above.

What do you think banks do to their interest rate offerings for people that have no security or job compared to those that have both? The government debt markets, or corporate bond markets, are really no different - albeit it usually with less dramatic differences - especially the further out the curve you go.

[NotSure]

Not a great quality article, and USA focus, but these issues are discussed here: https://www.marketwatch.com/story/the-wild-bunch-have-taken-control-of-the-bond-market-heres-where-they-could-wreak-havoc-next-1448322b?mod=home-page

...“The worry is that the escalating federal budget deficit will create more supply of bonds than demand can meet, requiring higher yields to clear the market; that worry has been the bond vigilantes’ entrance cue,” he says.....

....And here’s where he’s on guard for trouble, as he notes that the wild bunch have oddly left the high-yield corporate debt market — flat and stable –alone.....

....“Could it be that some of them view the government’s securities as riskier than high-yield corporates? The result of their rampage in the Treasury market suggests as much,” he said, adding that they are on alert for signs of rampage spreading to high yields......

[GoSeigen]

Not a great quality article, and USA focus, but these issues are discussed here: https://www.marketwatch.com/story/the-wild-bunch-have-taken-control-of-the-bond-market-heres-where-they-could-wreak-havoc-next-1448322b?mod=home-page

...“The worry is that the escalating federal budget deficit will create more supply of bonds than demand can meet, requiring higher yields to clear the market; that worry has been the bond vigilantes’ entrance cue,” he says.....

....And here’s where he’s on guard for trouble, as he notes that the wild bunch have oddly left the high-yield corporate debt market — flat and stable –alone.....

....“Could it be that some of them view the government’s securities as riskier than high-yield corporates? The result of their rampage in the Treasury market suggests as much,” he said, adding that they are on alert for signs of rampage spreading to high yields......

They're more than a year late noticing that! They should read TLF....



Personally I think it likely that gilts will follow treasuries.

GS

[Jwdool]

I can't see the relationship between gilts and treasuries holding. The US is on a phenomenal run - fuelled by increasing demand for it's industrials as Europe/ EU/ UK are getting crushed by higher energy costs (relatively speaking). The jobs market in the US looks hot (see JOLTs today) and the economy appears to be weathering higher rates for longer. By way of contrast, all the major macro data in the EU/ UK is turning downwards - PMIs, mortgage approvals, employment and obvs CPI/PPI.

I suspect we'll see USD trading higher - but at some point rates will come off in UK/ EU and stay higher for longer in US.