(Bloomberg) -- All roads lead to fiscal loosening in the U.K. and the gilt market is too complacent about the risks to the public finances.
The upside deficit risks associated with the Conservative Party’s proposed tax cuts and spending increases, as well as the chance of a left-wing government led by Labour’s Jeremy Corbyn, still have room to be priced into U.K. bond markets.
- The rising threat of a no-deal Brexit and risk of a general election should see fiscal concerns reflected in a steeper 10s30s curve, with 30-year and longer tenor gilts reflecting higher credit risk, as seen during 4Q of 2018 amid heightened fears of a chaotic departure from the EU
- Increased expectations of an expansionary fiscal policy may see the market unwilling to keep sizable risk further out on the curve; the DMO’s long-dated syndication in September could see weak take-up given the close proximity to the Brexit deadline of Oct. 31
- The gilt market relies heavily on foreign demand and long end may suffer if the fiscal situation deteriorates, with the OBR’s 2019 fiscal risks report this month stating "all the signs point to a fiscal loosening and less ambitious objectives for the management of the public finances"
- Besides 10s30s gilt steepener to hedge against no-deal, increased fiscal concerns could also lead to tighter long-end swap spreads; so far this year gilts have held up well against swaps given concerns about a slowdown in global growth, money markets pricing a BOE rate cut by March 2020 and hedging against an disorderly Brexit
- NOTE: Tanvir Sandhu is a global fixed income and derivatives strategist who writes for Bloomberg. The observations he makes are his own and are not intended as investment advice