Gilt Complex: Is Britain in Hock to the Bond Market?

Summary

Many Happy Returns – “Gilt Complex: Is Britain in Hock to the Bond Market?”

Date: July 22, 2026
Hosts: Ramin Nakisa & Michael Pugh

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Episode Overview

This episode explores whether the UK government is truly constrained by bond markets ("gilts") or whether the narrative of fiscal constraint is overstated. With Andy Burnham on the verge of becoming Prime Minister—and public concern over high debt service costs and elevated gilt yields—the discussion delves into market drivers, unique British vulnerabilities, structural shifts in the investor base, and the practical policy options available. The show balances macroeconomic analysis, historic context, and policy prescriptions, concluding with a fascinating discussion about the world’s oldest bond.

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Key Discussion Points & Insights

1. Political Context & The “Giltocracy”

• Andy Burnham is poised to become the UK’s fourth PM under King Charles. He once said Britain needed to “get beyond being in hock to the bond market”—prompting scrutiny over the government’s fiscal credibility and policy choices ([00:44]-[02:34]).
• Quote:

  “I was trying to popularise the idea of a guiltocracy where you run the country on the behalf of the bonds issued by the government.”
  —Ramin ([01:35])

• Host discussion notes how market reactions quickly forced Burnham to walk back the “in hock” rhetoric and re-emphasize adherence to fiscal rules ([02:34]-[03:09]).

2. Drivers of Gilt Yields: Domestic vs. Global Factors

• UK 10-year gilt yields are near 5%, the highest since 2008. The IMF attributes most yield movements to global factors, except for episodes of domestic turmoil—like the September 2022 “mini-budget” crisis ([04:22]-[05:27]).
• Quote:

  “During the big debt sell off in 2022, the truss episode... that flipped the drivers to being more domestic... Eventually it became global factors again. But the normal situation is that it is global factors that drive UK bond yields.”
  —Ramin ([04:32])

• Since 2020, global factors explain 60-90% of gilt yield variation, but domestic policy shocks sharply raise sensitivity ([05:27]).

3. Lasting Damage: The “Moron Premium”

• The 2022 “mini-budget” (Truss) has left a structural mark—UK gilts’ term premium is now much more sensitive to domestic political uncertainty ([06:41]-[07:45]).
• Quote:

  "After September 2022, gilt yields suddenly started to pay attention to what British politicians were doing."
  —Michael ([09:07])

• Economic Policy Uncertainty (EPU) metrics soared post-Brexit and spiked again during the mini-budget, shifting bond market behavior ([08:06]-[09:38]).

4. Inflation and Gilt Market Pricing

• Inflation expectations are stubbornly high: 5-year breakevens at 3.4%, 10-year at 3.2%, well above the Bank of England’s 2% target ([11:26]).
• Wages and regulated prices (energy, water, transport) underpin sticky services inflation ([12:16]-[13:23]).
• Quote:

  “Services inflation in May was still 3.7% and that’s a big slice of the economy.”
  —Michael ([12:51])

5. Bank of England’s Response

• The Monetary Policy Committee is split; ongoing rate hikes seem likely because of persistent wage-driven inflation ([13:50]-[14:15]).
• Quote:

  “We just got used to having zero interest rates, free money, and that world is just gone now. And it's taking people a long time to adjust to that...”
  —Ramin ([14:19])

6. UK Fiscal Position & Debt Sustainability

• Public borrowing for May was the second-highest on record for that month; debt interest projections for the year are £100–109 billion—more than the education budget ([16:39]-[19:48]).
• Quote:

  “Around a quarter of our public debt is linked to inflation, which is much higher than any other country.”
  —Michael ([20:10])

7. Structure and Holders of UK Debt

• UK maintains unusually long average gilt maturities (~14 years vs 6-9 in other G7 nations) ([21:47]).
• Defined benefit pension funds—once large, stable buyers—are closing, with holdings set to fall sharply. Overseas buyers (now ~⅓ of gilts) and hedge funds (now ~60% of daily volume) are “flightier,” raising market risks ([22:06]-[25:34]).
• Quote:

  “You can't get much more flighty than hedge funds. The first sign of trouble, they're not going to hang around.”
  —Ramin ([25:34])

• Declines in pension fund holdings could add nearly a percentage point to borrowing costs in the long term ([24:18]).

8. Are 5% Yields Fair? Sovereign Credit Risk and Inflation

• Hosts debate if current yields are “mispriced” or justified by the risk of persistent inflation and eroded credibility ([26:34]-[27:13]).
• UK’s credit rating has dropped three notches since 2014, but hosts are skeptical UK would ever default; inflation, not solvency, is the main risk ([27:28]-[28:43]).
• Quote:

  “What is the tail risk that justifies 5% yields? Is it the fact that inflation could run really hot if a government...refuses to raise taxes... and we go from spending £100 billion a year on debt interest to 150 to 200?”
  —Michael ([28:43])

9. Debt Quality: What Have We Bought?

• The UK’s large debt stock (~£3 trillion) hasn’t yielded much in terms of productive investment; most has gone to current spending rather than infrastructure ([29:30]-[30:11]).
• Quote:

  “Not all debt is created equal or at least spent equally.”
  —Michael ([29:30])

10. Policy Prescriptions: What Can be Done?

• IMF Guidance ([31:11]-[33:06]):
  • Fiscal consolidation: spend less, issue less net debt
  • DMO should shorten gilt maturities, reduce index-linked issuance
  • BoE should manage asset sales predictably
  • Consolidate fiscal events (annual budget only)
  • Strengthen market infrastructure, esp. regarding hedge fund-driven liquidity.
• Quote:

  “One of the big protectors of our democracy as we used to have it is gilt yields.”
  —Ramin ([33:06])

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Notable Quotes & Memorable Moments

• On Gilt Sensitivity Post-Truss:

  "Following the September 2022 episode, the UK term premium became significantly more sensitive to domestic political uncertainty.”
  —Michael quoting IMF ([07:05])

• On Public Understanding:

  “Who on earth, if you’re walking down the street, would ever mention talking about gilts? But if you talk about buying crypto, lots of people have an opinion.”
  —Ramin ([23:27])

• On Gilt Investing:

  “It’s just lovely being paid by the government. I always get a little free when I see those coupons arrive.”
  —Ramin ([26:34])

• On Debt Quality:

  “We’ve borrowed close to £3 trillion and we don’t have much to show for it. We haven’t used that borrowing to fund investment... we’ve effectively debt financed current spending.”
  —Michael ([29:30])

• On Accountability:

  “What I think is good about worrying about your government bond market is that it’s controlled behavior of governments... if anything, one of the big protectors of our democracy... is gilt yields.”
  —Ramin ([33:06])

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Timestamps for Important Segments

| Timestamp | Segment / Topic | |-----------|--------------------------------------------------------------------------| | 00:44 | Introduction to Andy Burnham’s “in hock” comment, context for episode | | 03:49 | Overview of global vs. domestic factors in gilt pricing | | 06:41 | “Moron premium” and lasting fragility post-2022 mini-budget | | 09:38 | Rise in sensitivity: EPU & term premium explained | | 11:26 | Inflation breakevens and market pricing | | 13:23 | Wage inflation and Bank of England policy splits | | 16:39 | Public borrowing and debt interest projections | | 20:10 | Uniqueness of UK: index-linked debt and implications | | 22:06 | Loss of big domestic buyers & rise of overseas, hedge fund holders | | 24:38 | Impact on yields from pension fund withdrawal | | 26:34 | Retail perspectives and sovereign credit rating discussion | | 28:43 | Inflation as the main tail risk for UK bonds | | 29:30 | Critique of UK’s debt-funded investment | | 31:11 | IMF policy prescriptions | | 33:06 | Concluding insight: bond yields as discipline/enforcer | | 34:15 | Dumb Question: World’s oldest bond | | 35:10 | Details on the 1624 Dutch perpetual bond | | 36:13 | War loans and the history of perpetual bonds in the UK | | 37:59 | Austrian century bonds and duration risk |

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“Dumb Question of the Week”: The Oldest Bond in the World ([34:15]–[38:44])

• Topic: Oldest continuously paying bond
• In 1624, a Dutch water authority issued a perpetual bond at 2.5%—still honored today, though inflation has reduced its real value to about €15 per year ([34:23]-[35:30]).
• Physical collection of coupons is still possible, and the bond itself resides part-time at the New York Stock Exchange ([35:43]).
• The UK’s own “war loans” and perpetual consols were only redeemed in 2015 ([36:26]); hosts discuss why perpetuals are out of favor and the risks of ultra-long-term bonds ([37:13]-[38:44]).

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Conclusion & Takeaways

• The UK is indeed “in hock” to the bond market—but so are all advanced economies.
• The 2022 “mini-budget” crisis did lasting damage to the UK's fiscal credibility, raising term premia and yield sensitivity to domestic uncertainty.
• Current high gilt yields are seen by hosts as a mix of rational inflation fears, structural market shifts (loss of pension fund demand), and residual risk aversion from past fiscal misadventures.
• True fiscal room for maneuver is tightly constrained; credible, consistent policy is vital.
• The hosts stress the dual identity of UK citizens—as both taxpayers and bondholders—and argue for greater retail participation and public understanding of gilts.
• Memorable aside: the world’s oldest bond story reminds listeners that government debt, when structured well, can transcend generations.

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For Listeners:

Aspiring investors and policy watchers will find this episode a comprehensive and candid guide to the realities of UK government debt, its market constraints, and why ordinary people should care—whether as investors, voters, or taxpayers.

Transcript

[A]

This episode is sponsored by Raisin uk, the award winning online savings marketplace. Compare open and manage competitive savings accounts from over 40 FSCs, protected banks and building societies with a single login. Use the Raisin link in today's show notes for a 100 pound welcome bonus. New customers. Only terms apply. Andy Burnham once said that Britain had to get beyond being in hock to the bond market. Easier said than done when gilt yields are 5%, debt, interest is running above £100 billion a year and the autumn budget has no headroom left. So can the UK escape fiscal fatalism?

[B]

I want to know whether the gilt market is a genuine constraint or just a convenient excuse. And in today's dumb question of the week, what's the oldest bond in the world and is anyone still getting paid? All right, let's get into it. So Andy Burnham is about to become Prime Minister as we're recording this on Monday, and he is, I believe, the fourth Prime Minister of King Charles's short reign.

[A]

I wonder if Charles just laughs when he sees them, you know, oh, hi, which one were you?

[B]

He just starts the clock. But as Andy Burnham comes into office, the question is really, what's he going to do differently and what can he do differently? So he had a kind of infamous quote, didn't he, not so long ago where he said Britain needs to get beyond being in hock to the bond market. What do you think he meant by that?

[A]

Yeah, I was trying to popularise the idea of a guiltocracy where you run the country on the behalf of the bonds issued by the government. So, I mean, that's an extreme way of putting it, but I think we should take Burnham's comments in context. He was having an interview with new statesmen and he was talking about a broader spending program. Typical Labour stuff, right? It's like large scale council house building, re nationalization of key utilities and of course higher taxes on top earners and wealth. So I think he was just laying out an agenda which is fairly standard practice for Labour. Pretty much a return to what they've talked about in the past. But of course that worried people because what you don't want is a government that's completely fiscally irresponsible and if markets felt that was the case, then gilt yields would spike. So maybe someone whispered in his ear, andy, you don't want to say that.

[B]

He did start to walk it back quite quickly, or at least said he'd stick to the fiscal rules as they

[A]

currently exist, which is not going to be easy because in the UK we've got very little wiggle room. And if he sticks to the pledges on not increasing debt over the course of this Parliament, well, that's a huge constraint. Unless he somehow fiddles the rules, reclassifies some of the debt as being not part of the overall net debt burden.

[B]

I just thought it was kind of funny that he said we don't want to be in hock to the bond markets. And then the bond markets had a bit of a wobble about him saying that, which is what got him to row back on his words.

[A]

And then he got the ex head of the obr, Richard Hughes, to give him advice about how not to spook bond markets. So at least he cares if it shows that he is wary of what happens with gilt markets if you spook them. And he knows now what not to say.

[B]

We'll see. But I guess the broader point here is that to some extent all governments rely on borrowing. They're all in hock to the bond market to some degree, unless they're running a fiscal surplus year after year. The question here really is, are the constraints on Britain's fiscal position significantly worse than other countries in Europe?

[A]

Now, one of the things I like about the fact that people are worried about UK debt is that gilt yields are relatively high. So if you talk to someone in Europe or someone even in America, they've got lower government bond yields. So currently if you buy a 10 year gilt, you earn just a shade under 5% and that's been gradually creeping higher over the course of this year. So it's at a two month high and it's been increasing over the last week, for example, as we record this, and that's the first time since 2008 that it's touched that 5% level.

[B]

But how much of that move in yield is specific to the UK versus being driven by global factors and a move up in yield curves around the world?

[A]

Well, the imf, who knows a thing or two about sovereign debt, they published something in June of 2026. One of the things they did was to look at movements in the yield curve and they break it down into its statistical components. So the first principal component is just an up and down shift in the cost of borrowing across the entire curve. And what they did was to look at the drivers of that. Is it external or is it internal factors, for example? And what's really fascinating is they showed that during the big debt sell off in 2022, the truss episode that flipped the drivers to being more domestic now that was fairly short lived. Eventually it became global factors again. But the normal situation is that it is global factors that drive UK bond yields. And it went very domestic during that huge sell off.

[B]

Let's put some numbers on it. So I believe the IMF estimates that since 2020, on average, global factors explain around 60 to 90% of the variation in gilt yields. But as you say, that share dropped sharply around the mini budget crisis, especially at the long end of the curve. And then once again over the last year or two, domestic factors have come to the fore again, especially I think when we've experienced this energy shock where the UK is not very well positioned.

[A]

Now, clearly the government is trying to move away from being heavily dependent on fossil fuels, but that's going to take decades. It's not going to be one parliament, it's not going to be one political party that does it. And while we remain a very open economy, we're hugely dependent on what happens around the rest of the world. Factors that we have no control over. So in a sense we're in hoc to the bond market, but it's the global bond market that we're in hoc to. But also geopolitical factors around the world and things like yields elsewhere over which we have no control. It is the case that you get high correlation amongst developed market bond yields. So if you have a spike in one country, it bleeds over into another.

[B]

But that's not to say we haven't had some own goals. So let's just quote the IMF. Market feedback suggests that the September 2022 gilt market turmoil marked a structural shift in the fragility of the gilt market.

[A]

Yeah, this is the moron premium that we were paying for quite a while after that episode. And markets take a long time to forget when you screw with them.

[B]

Can I quote something to you from the IMF paper and you can explain it to me, Romin, with your knowledge of statistics. Okay, so they say that following the September 2022 episode, the UK term premium became significantly more sensitive to domestic political uncertainty. Investors began to assign a higher risk premium to perceived policy uncertainty. Economically speaking, a one standard deviation change in the monthly economic policy uncertainty is associated with a 4.6 basis point increase in the term premium after the gilt market turmoil.

[A]

Now I love these economic policy uncertainty measures. It's so cool. There are various ways you can generate them. You can look at news stories and look for things like uncertainty tied up with words about the economy.

[B]

You can just look for mentions of the lettuce on social media. Indeed.

[A]

Or you can look at volatility of things like inflation expectations, GDP expectations. So there are certain measures you can look at to see whether things are changing behind the scenes. And if these things are flopping around, huge increases in inflation expectations or decreases, huge GDP increase or decrease expectations, well, that tells you there's huge economic policy uncertainty. And as we've flipped from one Prime Minister to another, one party to another, then that's just increasing the uncertainty, I think. But just looking at this EPU graph, essentially it just bobs along between 2000 and 2016, and then with the Brexit referendum, it goes off the scale, it rapidly falls again and then it stays at this fairly elevated level until 2021 and then things calm down for a bit until we get the huge own goal of that trust, mini budget. And they haven't really subsided that much after that spike.

[B]

Yeah. And the interesting thing the IMF does is correlate that economic policy uncertainty to the term premium for UK gilts. And before September 2022, the relationship between those things was statistically zero. There was no relationship. Economic policy uncertainty could go up and down and it didn't affect the term premium for gilts. Whereas after September 2022, gilt yields suddenly started to pay attention to what British politicians were doing.

[A]

Now, that term premium sounds a bit technical, but it's very simple. It's just the difference between 10 year and 2 year yields. So you could say that people demand a higher compensation for locking in their yield for longer. If it's the case that they're worried about, say, credit risk for a country, more likely they're worried about what's going to happen to yields over the next longer period of time. Greater uncertainty means that there's a greater risk that you get an inflation shock, anything which could erode the value of gilts. So the term premium is that credit risk premium proxy, or you could think of it as some kind of fiscal credibility measure.

[B]

I did find it interesting that this paper sort of put numbers on the fact that there has been lasting damage to UK credibility with financial markets from that mini budget crisis, because it's hard to tease that out when you just look at the sort of raw yield curve of the UK versus America and Europe.

[A]

And this puts numbers on something that I've got a feeling about, which is that the quality of politics, the quality of policy, politicians and the ideas that they come up with has got worse over time, or at least more uncertain.

[B]

Yeah. The thing I always want to push back on is the idea that the bond market is punishing Britain unfairly. Perhaps it is punishing us slightly, but maybe we've earned it. But the bigger thing it's doing is nothing about punishment. It's trying to price in the risks, particularly around inflation. If you look at gilt yields versus energy prices and services inflation, there's a clear correlation there. Bond markets are nervous about inflation in Britain and whether it's going to be worse over the coming decade, say than in the rest of the world. Yeah.

[A]

Just looking at UK breakevens right now at the 5 year point, it's 3.4. At the 10 year point, 3.2 at the 20 year point, 3.3. So what that means is that what we're pricing into our yield curve is very chunky, 3% plus inflation over the next 5, 10, 20 years and of course the bank of England's targets too. So essentially we're pricing in a lack of credibility into our yield curve.

[B]

Yeah, but inflation has averaged 3% per year in the UK since 2010, so why wouldn't you price that in? And if we look at CPI right now, it was 2.8% in May and the bank of England expects it to go up a bit to around 3% in the coming months and probably more like 3.25% by the end of the year.

[A]

Now some of that's exogenous. It's stuff that the bank of England can't control, energy dependence and energy shocks due to wars in the Middle East. Some of it though is based on things like UK regulated prices or administered prices where the government essentially sets prices based on their own rules. So here we're thinking about things like the off gen price cap, water and sewerage bills where you've got price limits set in five year chunks, public transport fares if you've got caps or regulated

[B]

increases, and arguably a big one is the price of labor. So the minimum wage has increased significantly over the years. Not saying it's a bad thing, but a lot of people are paid the minimum wage and for a lot of the service economy, where inflation is still hot, that's being driven by wage increases and an increase in things like national insurance. So services inflation in May was still 3.7% and that's a big slice of the economy.

[A]

So remember that when the bank of England talks about sticky inflation, this was the culprit. It was wages which were very sticky. And that component of inflation didn't fall very rapidly. It was just starting. In fact, just before we saw this war kick off in the Middle East. And now we're going back to the process that we saw previously. Inflation spike, people trying to get compensation for the inflation spike. And then you get this sticky wage inflation again.

[B]

And the Monetary Policy Committee at the bank of England is split. So there were two dissenters last time round who wanted an immediate hike in rates.

[A]

So I think what we're likely to see is more hawkishness, more willingness to raise interest rates from the MPC in order to stave off this stickiness of inflation, which is understandable. I think you can see the arguments behind it and they are credible.

[B]

Do you think policy as it stands now is restrictive?

[A]

I think it is. Just look at the graph and you can see that compared to where we were during that zero interest rate period, it's obviously higher. But the question is, what effect is that having on the economy? And I think the fact that the MPC is split suggests that different economists will see that restrictiveness differently. I think my view is that it is restrictive given where we are now, because we just got used to having zero interest rates, free money, and that world is just gone now. And it's taking people a long time to adjust to that, both in terms of mortgages, but also in terms of savings. People still think savings rates aren't great, but in fact I think they're pretty good now.

[B]

I suppose it's not great news for the UK that the oil price has gone back above $90 a barrel this week as the Iran war heats up again.

[A]

Yeah, these exogenous shocks are very painful for the uk and it's unfortunate that things were just starting to improve before this war really started to kick off. And it has been dragging on a long time. What should have been a very short war, according to Trump, hasn't turned out that way as many people expected it wouldn't. When it comes to your cash savings, making sure your hard earned money is working for you is important. But chasing competitive interest rates can mean dealing with a mountain of paperwork. Meet Raisin uk, the award winning online savings marketplace. Instead of the hassle of opening multiple bank accounts across different apps and providers to get a better interest rate, Raisin UK lets you compare over, open and manage competitive savings accounts from over 40 FSCs, protected banks and building societies, all through a single login. What's more, new customers can claim a £100 welcome bonus. Simply register for an account using the code July 100 and open and fund a fixed rate bond of one year or longer with a minimum £25,000 single deposit by 31 July 2026. Don't let your savings sit idly in a low interest high street account. Visit the link in the description and use the code July 100 new customers only terms apply.

[B]

So clearly bond markets are worried about whether UK inflation is potentially stickier than in other countries. But they're also worried about whether our fiscal position is sustainable. Certainly the latest borrowing figures are a little bit concerning. So the UK government borrowed a little over 23 billion pounds in May, which is the second highest on record for that month. And if you look at the first two months of the financial year, public sector net borrowing was 24% higher than last year, totaling around 46 billion pounds, and significantly was almost 9 billion pounds more than was forecast by the OBR.

[A]

Now there are monthly variations, so it's usually better to look at longer term averages of the amount of issuance. And what's really important is to look at net issuance, which is the amount of bonds issued minus those which have redeemed, where people have got paid back. And recently we've been running at around 300 billion in gross issuance and about 130 to 160 net. The huge spike was after Covid, because that's when we decided to fund things via issuance in order to just keep the country running.

[B]

Dodgy PPE doesn't pay for itself.

[A]

But I think what's reassuring is that this government has definitely said that the amount of debt matters and that hasn't changed under the new premiership. So I think it's unlikely that we're going to have a huge increase in debt to GDP. We should keep on bobbing around at around 100%. Just under 100% in the UK.

[B]

Yeah, I think it's around 95% of GDP right now, public sector net debt, that is, which is a lot higher than in recent decades. It's more like it was in the early 1960s. But as you said, the big increases tend to come with big shocks. It's the financial crisis and then Covid. So whether we get another big increase really depends on whether we get another big shock.

[A]

And that's the worry. We've got less capacity now than we had previously in order to absorb one of those shocks and to stimulate the economy. So if we do get another shock, I'm concerned that we're not going to be able to afford it. And it could be something like a war with Russia. And that's a particularly painful thing because it costs so much to do.

[B]

There are other reasons why it's painful as well, but yeah, the money aspect

[A]

is bad, but ultimately these wars are won and lost based on bond issuance. How much can you afford to spend and will people carry on buying your debt? And I'm worried that in the UK we've got less capacity for that now.

[B]

Singing from the IMF hymn sheet there, Romin, they're always talking about we've got less capacity to weather shocks. Perhaps an underrated reason why government debt has been increasing and borrowing is high is paying the bill on previous borrowing. So debt interest for the current fiscal year is expected to exceed 100 billion pounds, probably something like 109 billion, according to the OBR, which for context is more than the entire education budget, for instance.

[A]

So in terms of total public spending between 2025 and 26, we're spending about 1.4 trillion pounds. So that makes up about 7 or 8% of our total spending. So if you're just paying interest on those gilts and the amount of gilts is increasing relative to gdp, you can see why the OBR is worried about sustainability.

[B]

And you have to say that the UK is in a pretty unique position in that around a quarter of our public debt is linked to inflation, which is much higher than any other country. And that has generally been good for the UK in the era of low inflation and low interest rates. We turned a pretty big profit on that compared to the counterfactual. We just issued nominal bonds, but that's turned around. And if you look at debt interest in May, it was around 11.7 billion, which was a record for the month. And that was largely driven by the capital uplift on linkers. 4.9 billion of it was due to that.

[A]

The pension crafters love linkers. Some of the people in the forum, they talk about huge holdings. So it's interesting that if you turn it around and see it from the savers point of view, this could actually be a huge benefit to people if you do want some kind of inflation hedge in your income overall.

[B]

But we are both taxpayers and bondholders.

[A]

That's right. The other thing which is unique to UK debt is that it tends to be longer duration. Now that's been a good thing in the past. The US typically issues much more of this short term debt, so if yields rise very rapidly, then it picks up those higher funding costs very quickly, whereas in the UK we didn't. And it is the case that the UK DMO has moved to shorter term issuance as a result of those higher term premia.

[B]

You say that the UK debt has a longer maturity than Other countries. How much longer is it significant?

[A]

It is pretty stark. If you compare to the rest of the G7, the weighted average maturity of our debt is just under 14 years. It's 6 to 9 for the rest of the G7. And we also have the largest share of 30 year plus bonds in the G7. So a lot of very long dated paper.

[B]

One of the reasons for that is that the big buyer of long dated debt in the UK was defined benefit pensions. They love this stuff because they needed it to be sure they could meet their liabilities long into the future. But as we know, defined benefit pension schemes have been closing down, at least to new members, and that buyer is not really there at scale anymore. The Office for Budget Responsibility thinks that defined benefit pension assets will fall from around 30% of GDP today to just 11% in the decades to come. And at the same time, overseas holders have become more important. So they own around a third of the gilt stock and that is flightier money.

[A]

And one thing that you notice in other European markets, at least Italy, for example, is that domestic buyers make up a very large percentage of the holdings. Now that's very sticky money. It's not flighty and it's great because it pushes down the cost of borrowing. If only we could get more people on board when it comes to buying gilts in the uk, I think that would be great. I'm doing my part trying to educate people about it, but I think it's very much a misunderstood thing. Who on earth, if you're walking down the street, would ever mention talking about gilts? But if you talk about buying crypto, lots of people have an opinion.

[B]

But I guess it was pension funds that were buying gilts on behalf of their members, so people didn't need to think about them directly. That's no longer true. As we've said, defined benefit pensions are not there. Buying loads of gilts anymore. And do you think that will have an impact on yields? Because it's a massive structural change in the market. The fact that one of the main buyers is not a major participant anymore.

[A]

And that paper's going to be around for a long time. If you think about a 30 year bond, that's going to take us well past 2050 until it matures. So there's nothing you can really do. You can retire the debt, but I doubt that's going to happen. But to put numbers on it, the IMF paper estimates that a 1 percentage point rise in pension fund holdings results in a 5.4 basis point fall in yields but that's massive in terms of the cost of funding.

[B]

Yeah. To flip it around, I think the OBR's estimates are that the decline in pension sector gilt holdings could add almost a percentage point to government borrowing rates. So something like 0.8 percentage points over the long term, assuming that the debt stays near 100% of GDP.

[A]

So instead of criticizing bond markets, I think we should be trying to encourage people to buy our debt either by just having more credible policy or education. I think retail investors could pick up some of that slack in the uk, certainly if you compare us with the rest of Europe.

[B]

But almost a 1 percentage point increase in gilt yields versus the counterfactual due to this change around pension funds. 1 percentage point is massive, isn't it?

[A]

Absolutely. We're looking at 5% yields at the 10 year point. That would shift up to 6, which is huge as a proportion.

[B]

Of course, it's one factor amongst many driving yields. If you look at the day to day thing that's driving yields, it seems to be hedge funds. Now they're accounting for around 60% of daily gilt trading volume. To give some context around that, it's more like 30% of the volume in the US.

[A]

Now you talked about flighty investors. You can't get much more flighty than hedge funds. The first sign of trouble, they're not going to hang around. Now some of those trades are going to be basis trades where they're trading one thing versus another, an arbitrage trade which might be levered and in turn that might cause instability of the market. So I'm sure the bank of England's quite worried about that. At least with retail investors. They're buy and hold investors for the large part. But just think about it, 6% over the next 10 years for a gilt. Compare that with the average return on equity, that would be maybe 8 or 9%. So these are bonds for goodness sake. I think that's a really interesting opportunity.

[B]

Once again though, we are the taxpayers and we are the borrowers here. We've got to be careful to look at it from both angles. I would say. We live in the uk, we're reliant on our public services being funded and we're going to be paying the tax hikes if they come to pay the bill.

[A]

Yeah. The way I see gilts is kind of like a voluntary tax, whereas with other taxes you don't have a choice. With gilts you do have a choice. You can recoup some of that money and it's just lovely being paid by the government. I always get a little free when I see those coupons arrive.

[B]

But the way you're talking suggests you think there's a mispricing, like that they shouldn't be 5% at the moment. That's an unfairly high amount. I don't think that. I think it's like a fair pricing.

[A]

Well, I think it's fair, but it just feels like leaving money on the table if you don't take it. So I just think, well, that's why I kind of like buying them, because at least I get paid.

[B]

Is there any sort of tail risk that you don't get paid or you get paid in, like, a dramatically weaker currency? Because we have seen the UK sovereign credit rating sliding. It was AAA not that long ago.

[A]

Yeah. And this is from all three credit rating agencies, Moody's, Standard and Poor's and Fitch. Those have been gradually deteriorating since 2014, and we've moved down about three notches. But that is common to many of the developed market countries. Even the US has been downgraded. But if you think about it from a credit analyst point of view, you can see why a lot of these countries are running big deficits. Some of them don't seem to care. At least we do care about whether our deficit's too high.

[B]

We are in hock to the bond market. Is that what we're saying?

[A]

I think that's definitely true. I think every country is. And you don't have a choice about fiscal credibility.

[B]

But what does a sovereign credit rating for a developed economy actually mean? You're pretty consistent in saying we're not going to default on the debt, so who cares what the credit rating is?

[A]

I think that's true, and that's why I see higher yields if the yield is higher because of credit spread. Yeah, I'll take the other side of that bet. Are we going to become like emerging markets again by defaulting on our debt regularly? I don't think so. I just don't see the UK evolving into that kind of country. Even the most populous government is not going to default on the debt.

[B]

So what is the tail risk that justifies 5% yields? Is it the fact that inflation could run really hot if a government comes in and just sort of bows to public pressure? Keeps the triple lock, spends more on public services, refuses to raise taxes, and we go from spending £100 billion a year on debt interest to 150 to 200?

[A]

I think that's the fear. I think that inflation is the primary fear and a secondary Fear is that productivity increases are not going to be able to pay the bills. And we've got the demographic problems in the uk which is that the decreasing size of the population is paying for the older people and their care. So those are the big worries. But that's true across much of the developed and now the emerging world.

[B]

Perhaps the big thing that Britain's got wrong is that we've borrowed close to £3 trillion and we don't have much to show for it. We haven't used that borrowing to fund investment to build amazing infrastructure. We've effectively debt financed current spending. We've used it to push up the public sector pensions bill, retain the triple lock, give pay rises to public sector employees. Good things, but things which don't grow productivity. Not all debt is created equal or at least spent equally.

[A]

So it's nice to see in the budget when you see this decomposition of what the debt is used for versus the tax receipts. Tax receipts for everyday stuff, things like pensions, welfare, public services versus things like capital infrastructure spending being funded out of debt issuance. So at least the government's trying to do that. We don't seem to be able to do it as well as China.

[B]

Say no. HS2 would speak to that. China's railways high speed network over its whole country and we are still fighting about bat tunnels in the middle of nowhere.

[A]

Are you talking about Buckinghamshire again, Michael?

[B]

Okay, just to wrap up, I don't want to be too negative or fatalistic. There's always things you can do. And if we are in hock to the bond markets, who better to give us a policy prescription than the IMF themselves? I think there's three key bits of advice they've given the British government.

[A]

To some extent we're already doing this. The first one is about supply. So stay the course on fiscal consolidation in order to reduce net issuance.

[B]

And by fiscal consolidation we mean spend a bit less money.

[A]

Yeah.

[B]

Not easy to do when there's all these arguments about defense spending. And we've seen the Defense Minister recently resigned because there wasn't enough money allocated to the armed forces.

[A]

But also the structural stuff like issuing more at the short end. That's what the DMO's already doing. Reduce the amount of index linked bonds. Pity. I like them.

[B]

And they had some advice for the bank of England as well, didn't they?

[A]

Yeah. I never really bought the story from the bank of England that selling their gilt has not distorted the market. How can that be true? They've got such huge holdings and if you flog those then how's that not going to increase yields? But what the IMF says the way they should do it at least is to be predictable. And the bank of England stresses that their auctions are predictable. Have a pre announced path skewed away from the long end where it's particularly painful if yields spike.

[B]

The IMF also wants us to continue to improve our credibility, have just one fiscal event per year, a single budget, not a budget and a spring statement and all this stuff which we're kind of doing now.

[A]

Yeah, the word mini budget's not going to be used again for a while, is it?

[B]

But as well as all that, there is some sort of nitty gritty technical stuff. The IMF wants to see around improving the resilience of the repo market. And again, this is something we're apparently doing. The bank of England has done a system wide exploratory scenario review and we'll come up with policy proposals next year. Some of this is actually around that hedge fund stuff we touched on, that we're reliant on money that might not always be there. So you've got a risk of a liquidity crisis.

[A]

So what I think is good about worrying about your government bond market is that it's controlled behavior of governments. So it's stopped them doing the really crazy stuff that's happened in the us, it's happened in the UK and politicians are now much more wary about doing crazy stuff. Whereas rule of law norms that we've seen in the past, those haven't kept behavior in check. So if anything, I think one of the big protectors of our democracy as we used to have it, is guilt yields.

[B]

Put them on the ballot paper. Who you voting for? The guilt market or count binface? That is British democracy in 2026. Take your pick.

[A]

Now if you're thinking about things like bond ladders, post retirement income things like inflation linked bonds, well, we're the place to discuss that. So if you want to join the conversation, learn from our community, just go to pensioncraft.com membership to learn more.

[B]

Okay, today's dumb question of the week. What's the oldest bond in the world and is anyone still getting paid?

[A]

Hoch Heim Racht Sharp Lech Dike Boven dams.

[B]

Have you had a stroke, Romin? What's going on? What's this?

[A]

Well, of course, Michael, that's the local water authority in utrecht. So in 1624 they were the entity that issued this really old bond and it was in order to fund repairs to flood defences on the Lech River. So that's just south of Utrecht.

[B]

This is the most Dutch thing I've ever heard. Now this is a perpetual bond from 1624, like you said. And according to the Guinness Book of World Records, the Coupon payment is 2.5% of the principal, which was 1200 Dutch guilders.

[A]

Now this is a really nice example of why inflation and inflation linked bonds are a good idea. This wasn't inflation linked. And the effect of 400 plus years of inflation and of course currency changes, because we're now in euros rather than guilders, means that you only get paid out about €15 per year.

[B]

I think they're not actually collecting the coupon every year, they're letting it sort of accumulate and then making a physical trip to Utrecht to collect it when it reached a few hundred euros.

[A]

I love that.

[B]

It says here that a physical copy of the bond was presented to the New York stock exchange in 1938. I don't know if it was because the bond had sort of gone missing and someone just turned up with a piece of paper. Do you think that worries people in the debt management office that someone in the UK has some sort of South Sea certificate from the 1600s and they'll turn up and give them a piece of paper and then they're owed like £8 billion or something because it's all accumulated over the years.

[A]

What if it was a linker?

[B]

No, that's what I mean. What if there was some clause in it which means, you know, we haven't paid it all these years and there's penalty fees and now the UK's bankrupt and we owe everything to some random guy with a bit of paper.

[A]

Yeah, they'd have to change the law, wouldn't they? Whenever we used to have an idle moment at the bank, we always used to use the Bloomberg terminal to pick out the really weird bonds. It was such a wheeze working at the bank. But we used to look at these things, the war loans. These were perpetual bonds issued by the UK government. Unfortunately, they were redeemed in July of 2015. They were tiny in terms of the issuance in today's terms, but still it was an interesting historical artifact, almost. Almost like archeology in bond terms. So you had the 4% consolidated loan, the 3.5% war loan, four of those undated gilts in total, and they'd survived from 1727. So it was quite sad to see them go.

[B]

I hope they had a good send off. But why don't we issue perpetual bonds

[A]

anymore from the government's point of view, I guess they just don't think people want to buy them. Why would you want to lock in a fixed cost of funding forever?

[B]

I think you'd buy it and squirrel it away in a drawer.

[A]

I'll tell you what, if they gave me a certificate, you know, like one of those beautiful old bonds, certificate, I would buy it. Maybe not a huge amount.

[B]

A proper gilt edged one.

[A]

Yeah, yeah, yeah. I think that'd be so cool. But there are other issues about it. The liquidity would be almost non existent. It would hardly trade. So if you buy it it would be very difficult to sell. And of course the duration wouldn't be infinite. Right. It would cap out at about 25, 30 years, depends on the coupon.

[B]

And you never get a pull to par effect. I know Austria issued some 100 year bonds which is obviously not forever but it's getting up there.

[A]

Yeah. I think Austria's got two of these century bonds. The 2121 is trading at about €30 on €100 face value. So 30 cents on the euro.

[B]

That's duration risk, isn't it?

[A]

Just a bit. Yeah.

[B]

You lost 70% of your value in a few years. When does the pull to par effect kick in?

[A]

2120 for that one. And the 2117 bond is trading at about €57. Do you get a better yield for that one? But I don't think I'm going to make it to 2117.

[B]

Will Austria make it? That's what you got to think. Thank you for joining us for Many Happy Returns. Keep sending us your questions no matter how dumb@mhrnsioncraft.

[A]

And do remember to check out pensioncraft.com for all the information about our membership courses and investment coaching options.

[B]

Many Happy Returns is a Pensioncraft production co hosted and executive produced by Romin Nikiza and Michael Pugh. This podcast is for informational and entertainment purposes and is not financial advice. We do not provide recommendations or endorse any decision to buy, sell or hold any security. We cannot be held responsible for any actions listeners may take and investors are encouraged to seek independent financial advice.