Corbyn Scares U.K. Market Hooked on ‘Kindness’ of Strangers
(Bloomberg) -- With no-deal Brexit risks receding, investors in U.K. assets are turning their attention to the next market threat: a spendthrift government after the December election.
The pound’s status as the lead market barometer of U.K. politics faces a challenge from bonds, as analysts scrutinize spending plans during the campaign and worry about the prospect of capital flight. Labour leader Jeremy Corbyn has pledged to borrow to fund a 250-billion-pound ($324 billion) investment program, while Boris Johnson’s ruling Conservatives have also promised to turn on the taps after a decade of austerity.
It could mark a sharp turnaround in the U.K.’s debt market. Gilts have remained a haven for investors throughout the Brexit saga, with overseas buyers grabbing the securities this year at the fastest pace since 2016 to take their holdings to more than a quarter of the total. Bank of England Governor Mark Carney has called the country’s reliance on foreign investment the “kindness of strangers.”
These investors could demand a bigger premium for holding longer-term bonds, steepening the yield curve to reflect the deeper uncertainty, regardless of who wins on Dec. 12, say strategists. Nonetheless, Labour is seen as the riskier option, with Corbyn pledging to nationalize key industries and invest more in public services and infrastructure.
“If we end up with a Labour government or a government where Labour has significant influence then I would expect the risk to slip from sterling onto the gilt market,” said Artur Baluszynski, head of research at Henderson Rowe. “I’m expecting we could be approaching a balance of payments issue, where if Labour starts fiscal stimulus they are just going to start silly spending.”
Strategists worry that the market is vulnerable to a crisis of confidence from international investors if the U.K. unleashes a wave of spending. Britain’s public finances have also got worse as the economy suffers from investment uncertainty over Brexit, student loans that will never be repaid are now added to government spending, and as recording errors mean the Treasury has been collecting less tax from company profits than previously thought.
“There is certainly a risk that foreign sponsorship of the gilt market suffers, particularly if we start seeing changes to the U.K.’s institutional structure such as the BOE’s mandate,” said Sebastien Cross, a U.K. rates strategist at Bank of America Merrill Lynch. “While it would take some very extreme scenarios to see a full overseas buyers strike, the high proportion of the gilt market that is owned overseas naturally makes it vulnerable.”
Foreign investors have increased their gilt holdings by nearly 100 billion pounds ($129 billion) since the 2016 Brexit referendum, according to data from the BOE. The central bank is expected to cut predictions for growth in 2020 and 2021 at its next rate policy announcement on Thursday.
The country’s Debt Management Office said it couldn’t speculate on future revisions to its remit, but last time it faced a massive increase in funding requirements was during the financial crisis and it opted to issue more short-dated debt.
Investors are less worried about the spending plans of the Conservatives, who polls show are on track to be the biggest party in Parliament. Even as the party attempts to vie with Labour through spending pledges for health, education and infrastructure, the market is unlikely to lose confidence in this scenario, said Baluszynski.
“It’s a funny situation because what you have is a right-wing government with a left-wing approach to the economy,” he said.
Still, the Tories are less likely to discourage capital inflows and more likely to make small adjustments in order to deliver their campaign promises, he said. Corbyn, on the other hand, launched Labour’s campaign promising to “go after the tax dodgers” and name-checking prominent businessmen and bankers.
The gilt curve is likely to steepen gradually over the rest of this year as the market assesses the likelihood of increased supply, according to Adam Dent, a rates strategist at Banco Santander SA. The spread between two and 10-year gilt yields peaked in December 2016 and has been narrowing since, with economic stimulus likely to push it back to higher levels.
“Gilts have shown remarkable resilience to the Conservatives’ journey towards higher borrowing over the last few months,” Dent said. “We still expect gilts to steepen and their swap spreads to tighten over the rest of this year, but as more of a slow grind than a sharp correction.”
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