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Chart of the Day: here's when Britain loses its triple-A rating

Thankfully, a triple-A rating is no longer essential for low government bond (gilt) yields.

 

by Chris Marshall on Mar 26, 2012 at 10:55

Despite chancellor George Osborne’s swaggering, the UK is only just clinging onto its cherished triple-A credit rating, the thin armour deflecting attacks from nasty market assailants.

Does the UK belong in the increasingly exclusive triple-A club?

This chart from Citigroup – whose economists describe the UK as a ‘relatively weak triple A’ – suggests our membership may be due to expire. This holds whether you consider the more optimistic forecasts from the Office for Budget Responsibility (OBR), the independent budget watchdog, or those from Citigroup.

Both Moody’s and Fitch ratings agencies have put the UK on negative outlook, while the third of the big agencies, Standard & Poor’s, will surprise no one if (or when?) it makes the same threat.

But as the downgrade of the US last summer showed us, a triple-A rating isn’t essential for the low government bond yields that are allowing the government to borrow money cheaply; there are other forces at work.

‘We do not expect that a negative outlook – or indeed a ratings downgrade – would seriously derail gilts, given the sluggish economy and falling inflation, plus the government’s strong commitment to fiscal consolidation,’ commented the Citigroup economists in their research.

Or as Mike Amey, manager of the Allianz Pimco Gilt Yield fund , told Citywire: 'We don't think it would make any difference if gilts were AA or AAA rated.'

27 comments so far. Why not have your say?

Adam Eve

Mar 26, 2012 at 12:33

"Or as Mike Amey, manager of the Allianz Pimco Gilt Yield fund, told Citywire: 'We don't think it would make any difference if gilts were AA or AAA rated.'

EXCUSING MY ignorance then, what is the point?

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Truffle Hunter

Mar 26, 2012 at 13:27

"And as the downgrade of the US last summer showed us, a triple-A rating isn’t essential for the low government bond yields that are allowing the government to borrow money cheaply; there are other forces at work. "

Enabling low interest rates are, of course, are the digitised printing presses working to monetise all the debt away. The presses are busy in the US, Europe, and now Japan. There will be no debt left for Moodies, Fitch and S&P to downgrade eventually. The sea of worthless bank notes will be a sight to behold.

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peter hart

Mar 26, 2012 at 15:38

"They" rated Equitable Life AAA! Should have been aaaarrrrhhhh. So there is no point to it.

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Neil Murphy

Mar 26, 2012 at 19:56

I thought everyone realised how worthless they were after the credit crunch when they rated sub-prime mortgages as triple A.

I made a typo on this and wrote triple as tripe. Freudian slip I guess.

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nickle

Mar 31, 2012 at 12:44

Enabling low interest rates are, of course, are the digitised printing presses working to monetise all the debt away.

=============

Er ,it doesn't work for

a) Inflation linked Gilts

b) PFI

c) Civil service pensions

d) State pension

e) State second pension

f) Guarantees (just increases the losses)

g) Nuclear decommissioning (It's work, its linked to inflation)

So how does it get rid of all the debts again?

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William Bishop

Mar 31, 2012 at 19:38

There is a lot more debt in the whole economy apart from the categories mentioned by Nickle. In theory the combination of low interest rates and QE could generate higher inflation, if it proved effective in generating economic growth and enabling increased costs of, for instance, commodities to pass through into more generalised inflation of wages and prices. So far, however, there is virtually no sign of this actually occurring.

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Truffle Hunter

Mar 31, 2012 at 21:25

It is all just latter-day gold coin clipping. The Emperor has no money so he steals it. History shows this always ends badly. What is so different about it this time? I suppose we have econometricians that can fiddle with their discredited mathematical models and assume away all the inconvenient flaws in their economic theories, proclaiming everything will be OK! The models have been thoroughly discredited by this financial crisis and yet these academic clowns persist.

Low rates and QE will eventually create conditions where people start buying "stuff" just to protect the value of their paper money. This will stimulate the economy! But, it will be the beginning of hyperinflation. That will really make life interesting.

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nickle

Mar 31, 2012 at 22:00

In theory the combination of low interest rates and QE could generate higher inflation,

==========

It's happening. That's why Mervyn King has repeatedly write his. "Please Please Sir, let me have another go at controlling inflation, I'll get it right next time"

Meanwhile knowing full well he's going to fail, because its part of the plan, they move their pension into inflation linked gilts to profit.

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Truffle Hunter

Apr 01, 2012 at 09:49

nickle

2.5% Indexed link 2020 bond is priced around £363 per nominal £100. In 2020 you pick up a £263 loss of capital. A wise investment???

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nickle

Apr 01, 2012 at 16:27

No you don't. Please go and investigate what gets repaid on an indexed linked Gilt. You get index at end / index at start * 100

http://en.wikipedia.org/wiki/Gilt-edged_securities#Index-linked_gilts

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Truffle Hunter

Apr 01, 2012 at 16:39

Yes, but the inflation index is not going to compensate you for much of the capital loss if you purchase this instrument today. The index will also be massaged by the NSO to ensure the compenasation for inflation is kept to a minimum!

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Truffle Hunter

Apr 01, 2012 at 16:39

Yes, but the inflation index is not going to compensate you for much of the capital loss if you purchase this instrument today. The index will also be massaged by the NSO to ensure the compenasation for inflation is kept to a minimum!

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nickle

Apr 01, 2012 at 16:52

There is no capital loss. You need to read up on how inflation linked gilts.

Is there going to be an inflation adjusted loss? Then it depends on your measure of inflation and how it differs from RPI.

RPI itself is difficult to fudge. That's why the government prefers CPI. RPI can't be fiddled with, because of the Gilt market, They would sue, and win.

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Truffle Hunter

Apr 01, 2012 at 17:18

What price did you pay for your holding?

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nickle

Apr 01, 2012 at 17:48

I don't have a holding. However, I do know how ILG work.

You're assumption that you get 100 pounds back, for an 100 pound Gilt bought at 363 is wrong. You get the index at redemption divided by the index at issue, times 100.

It makes a big difference if you are basing your conclusions on something that isn't correct.

Similarly with the RPI / CPI or some other index issue.

ILG track RPI, so if you want a hedge against something other than RPI, you run what is called basis risk. That risk is that your inflation measure doesn't replicate the risk you want to hedge. The problem here is that there probably isn't a hedge for your inflation risk.

Now what are the risks with ILG? It's back to the credit rating. I strongly believe with evidence that the UK government won't honour its debts. The reason is that its debts exceed the total of Gilts by many times. Pensions are omitted.

The government can't honour Gilts and not honour pensions. The voters won't tolerate it. Add up all the liabilities and it's 1 trillion on Gilts, 6 trillion on other off the book debts.

So at some point the will default on Gilts. The important question is when?

Note, they can't use inflation to get out of ILG or pensions. They are all inflation linked. So they will partially default, for example, by raising the state retirement age (10-15% off the debt), changing the linkage from RPI to CPI. (another 15%)

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Truffle Hunter

Apr 01, 2012 at 19:40

Imagine you purchase this instrument today in the market at £360 per £100 nominal. Assume inflation at 6% what do you get back?

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nickle

Apr 01, 2012 at 20:33

http://pwlb.gov.uk/documentview.aspx?docname=/giltsmarket/formulae/igcalc.pdf&page=Formulae/Calc

has the details.

You will get more than 360 back. I think you're trying to claim that you only get interest plus 100. Am I correct in that is your thinking?

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nickle

Apr 01, 2012 at 20:48

You will need historical RPI

http://www.ons.gov.uk/ons/rel/cpi/consumer-price-indices/february-2012/cpi-and-rpi-detailed-reference-tables.xls

And then table 38

[By the way the ons site is the shittiest one I've come across in a long time. It's designed to make it opaque and difficult to find any data. You're taxes down the drain]

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Truffle Hunter

Apr 01, 2012 at 21:46

Nickle

Thanks for the links. I can see where we are apart in our thinking. My bearish stance is based on the assumption that a market price is paid for the bond i.e. not bought at par at the time of issue from the DMO. If this assumption is correct then it follows that what one gets back is unlikely to fully compensate for the inflation especially if a £100 nominal is trading currently at £360. Inflationary compensation would be based only on the £100 nominal value of the stock because the DMO will only return the inflation adjusted capital sum that they originally borrowed.

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nickle

Apr 01, 2012 at 22:40

Again, you can look at the evidence. Take the historical prices for the ILG of your choice, and compare it against inflation. You will see that it tracks very closely inflation.

You might be confusing yourself with the behaviour of a fixed rate bond and its relationship with interest rates.

If rates go up, bond prices in the market go down, and vice versa. The longer the maturity of the bond the larger the effect. As you get closer to maturity, because the effect is smaller, the price gets pulled to par, or the redemption amount.

This doesn't happen with linkers or with floating rate notes. Linkers track inflation, and floaters stay close to the redemption amount.

On your last bit, the will pay 100 pounds adjusted for inflation. (End index / start index )* 100

So if the 360 currently trading with the RPI index at around 238. Lets say in 2020 at maturity the index is 380. You will roughly get 380/238 * 360 or about 575 pounds back for your 360 pound investment. [6%, which is the figure your put forward. You also get interest along the way, but that is very small]

You're question is very similar to those who think there is free money to be had when stocks go ex dividend. There isn't, there is no free lunch. People would have moved in, and the price moved to remove the freebie.

In the case of the ILG only repaying 100, it would be such an awful deal people wouldn't enter in to it. However, people are buying ILG, so the assumption of 100 at redemption is going to be wrong.

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Truffle Hunter

Apr 02, 2012 at 09:43

OK Nickle

Here are the calculations for the 2020 linker I chose as an example, courtesy of the DMO:

Nominal Value including inflation uplift £18628Million.

Market Value currently £24313M

This means the yield to redemption is -0.91%.

If you buy these today you get a negative return!

I hereby rest my case.

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nickle

Apr 02, 2012 at 18:43

Do you get back 100 pounds or more than 360 if inflation is at 6% until redemption?

I don't see your calculations. Lay them out in more details.

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nickle

Apr 02, 2012 at 18:48

inflation linked gilt 2020

Last Price Update : 2 Apr 2012

Price : 365.235

Coupon : 2.5%

Maturity : 16 Apr 2020

ISIN : GB0009081828

Base RPI 82.97

Current RPI ?

Then post the calculations. You won't get a negative yield. You're applying a fixed rate methodology, although its not clear, to a linker.

If so, what are the future cashflows that you're assuming, to come up to a yield to redemption.

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Truffle Hunter

Apr 02, 2012 at 19:09

http://www.dmo.gov.uk/reportView.aspx?rptCode=D1D&rptName=102082824&reportpage=D1D

Page 2 look at the heading Redemption Yield - it is minus 0.91%. This the "rotten deal" to which you referred earlier. People would be mad to invest in these things now.

The DMO are not going to give you what you seem to expect. There is a bubble in government debt waiting to burst. Large internationals paying dividends will probably end up being the beneficiaries of the sell off in government paper. The sell off will be met by the B of E monetising the debts. We have to pray that this takes time to play out. If it happens too quickly the housing market will take it on the chin again, and the banks with it.

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nickle

Apr 03, 2012 at 08:09

So how much money do you get back in 8 years with inflation at 6%?

The problem when anyone says rotten deal, is that they never mention how rotten the alternative is.

You're making a comparison. What's the alternative?

What's the hard cash that you get back with both, in 8 years?

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nickle

Apr 03, 2012 at 08:09

On the DMO, their website is down.

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TruffleHunter

Apr 03, 2012 at 09:21

The rotten deal is illustarted by the DMO themselves on their website. A negative redemption yield should warning enough to stay away at the current time.

8 years at 6% - the value of the £ almost halves in real terms. So the DMO would pay you in depreciated currency. It might just about purchase the same basket of goods.

Alternatives? What is better a negative rate of return on government debt, or dividends from major international companies where you not only get the dividend but your capital generally rises in value as the international companies grow their franchise? In real terms you win with equities; with government debt you just about get back what you put in. Timing the equity purchase is the only thing you have to focus on. When these big companies correct their recenrt upward move -BUY

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