Investment planning update: The yield curve; UK dividend payments and more

 

• The Yield Curve
• The OBR has published its latest deficit projections
• Government borrowing plans
• UK dividend payments fall sharply

 

The yield curve

(AF4, FA7, LP2, RO2)

The UK yield curve is just where Rishi Sunak needs it – for now.

Last year we wrote several articles on the yield curve and what it seemed to be saying. Often, we were looking at the US yield curve and commenting that the inversion of the curve was traditionally a sign of a recession. There is no doubt a recession is what we now have – on a global scale – although it is hard to believe that ‘Mr. Market’, for all his collective wisdom, foresaw its cause, the COVID-19 pandemic. 

On this occasion, we are looking at the UK yield curve, albeit ‘curve’ is a generous expression given that 60 basis points (0.6%) just about cover the entire range from one month to 50 years. The graph highlights several points:

• Since the start of the year, the entire yield curve has sunk by around 0.7%, give or take 0.1%.

• The sharpest drop has been at the ultra-short end. This reflects the decline in base rate from 0.75% on 1 January to 0.1% now, with Bank of England mutterings about negative base rates in the background.

• As at 13 July – but it is a variable feast – rates up to six years were negative. Thus, very recently the Debt Management Office (DMO) was able to sell £3.75bn of 0¹/₈% Treasury 2023 at an average yield of -0.034%. The issue was 116% over-subscribed.

• At the 50-year end of the market, the yield is under 0.5%, which gives pause for thought. A shift upwards of just 0.25% would reduce the value of 1⁵/₈% Treasury 2071 by about 9%.

• The Conservative’s 2019 manifesto said of its fiscal targets, ‘… if debt interest reaches 6 per cent of revenue, we will reassess our plans to keep debt under control’. At the time of the Spring Budget the Office for Budget Responsibility (OBR) was projecting £800bn total revenue for 2020/21, a figure it revised in May to about £672bn (another revision is imminent). The OBR also revised its interest cost figure, which went down from £44.7bn in March to £42.4bn in May - 6.3% of revenue.

Negative and ultra-low rates are the main reason why the Chancellor can spend as he has been, potentially racking up £350bn of fresh borrowing (say 18% of GDP) in this financial year (on top of about £100bn of maturity refinancing). However, he will be as aware as anybody of the gearing effect of such low rates on servicing costs if, for whatever reason, yields rise.  It was as well that, at the end of 2019, the average maturity of the total stock of UK was 15.4 years (14.3 years for conventional stocks and 19.6 years for index-linked securities according to the DMO).  

Source: Investing.Com, Dmo, Tradeweb.

The OBR has published its latest deficit projections     

(AF4, FA7, LP2, RO2)

The Office for Budget Responsibility has (sort of) issued revised projections for its coronavirus scenario.

The recent Summer Statement was unaccompanied by numbers from the Office for Budget Responsibility (OBR). Such figures as there were came direct from the Treasury and represented little more than its cost estimates for the various measures Mr Sunak announced. The OBR had been scheduled to update its Coronavirus Scenario and issue its Fiscal Sustainability Report (FSR) on 14 July – six days after the Chancellor spoke. It has duly done so and the tone of the publication suggests a certain tension between the Budget monitor and the Budget setter.

For a start, the OBR says that it “did not receive a draft or advance copy of the Treasury’s document before its publication on 8 July”, even though it had requested details as soon as the Statement’s timing was announced on 30 June. The FSR’s main projections had been finalised on 26 June. Thus, the main FSR tables omit what the OBR estimates to be an extra £50bn of borrowing in 2020/21. That is £13bn less than implied by the Treasury’s estimates for a variety of reasons, notably:

• The OBR reckons the Job Retention Scheme – the single most costly measure announced – will end up costing £6.1bn, rather than the Chancellor’s ‘up to £9.4bn” which assumed every furloughed job as at 5 July would attract the £1,000 bonus.

• The Stamp Duty Land Tax (SDLT) cut will cost £2.5bn according to the OBR, whereas the Treasury figure was £3.8bn. Housing transactions are forecast to rise by 100,000 in 2020/21, but the OBR says that 75% of these will have been brought forward from 2021/22.

• The temporary VAT cut for the hospitality and associated industries has a cost of £2.5bn for the OBR, against £4.1bn for the Treasury. The OBR justifies the difference by saying that it assumes a ‘lower path’ for consumer spending in its scenario.

In fact, the OBR has now moved to three scenarios – Upside, Central and Downside – which are summarised in their table below (and exclude the impact of the Summer Statement):

	Scenario
	Upside	Central	Downside
Real GDP fall in 2020	-10.6%	-12.4%	-14.3%
Peak unemployment rate	9.7% (Q3 2020)	11.9% (Q4 2020)	13.2% (Q1 2021)
Net Borrowing in 2020/21*	£263.4bn	£322.0bn	£391.2bn
Net Debt in 2020/21+	94.8% GDP	104.1% GDP	113.2% GDP

 

^*  Add about £50bn for Summer Statement measures

⁺ Add about 2.2% for Summer Statement measures

The chances of the upside scenario were weakened by the ONS provisional figure of 1.8% for GDP growth in the month of May (19.1% down on an annual basis for the three months to May 2020). Looking longer-term, as the FSR does (see the graphs above), a dire picture emerges on all three scenarios. As the OBR says, ‘In all cases, the public finances would clearly be on an unsustainable path’.

The OBR can have the last word, which sounds like a reminder for the Chancellor’s Autumn Budget: ‘…given the structural fiscal damage implied by our central and downside scenarios, and its implications for long-term sustainability, in almost any conceivable world there would be a need at some point to raise tax revenues and/or reduce spending (as a share of national income) to put the public finances on a sustainable path’. 

Source: OBR 14/7/20

Government borrowing plans

(AF4, FA7, LP2, RO2)

The Treasury has released more details about how it will be financing the Government’s 2020/21 expenditure.

Eight days after a Summer Statement that announced ‘up to £30bn’ of extra pandemic spending (and hid ‘a further £32.9 billion of public services funding’ in the footnotes), the Treasury has fleshed out more details of its borrowing plans for 2020/21.

These now stretch out to November 2020, covering eight months of the financial year. The plan is to raise a minimum of £385bn in gilt sales over that period, up from £275bn in the period April-August. The Debt Management Office (DMO) has scheduled another 38 gilt auctions worth £110bn in the period September-November. The DMO’s next funding remit will be announced alongside the Autumn Budget.

The £385bn target is £85bn more than the Bank of England’s currently planned quantitative easing (QE) for 2020/21. There could now be another round of QE revealed when the Bank announces its next base rate decision on 6 August. However, the rate of gilt issuance will be slowing from today’s £60bn a month equivalent, so more QE is not a given. £217.1bn has been raised by the DMO so far in this financial year. The Office for Budget Responsibility (OBR) in its latest Fiscal Sustainability Report put the Government’s 2020/21 borrowing needs at between £393bn and £521bn, depending upon which of three economic scenarios is used.

The Treasury has also decided to increase National Savings & Investment’s (NS&I) financing remit for 2020/21. This was set at £6bn (±£3bn) in the Spring Budget, but on 14 July the Treasury upped the figure to £35bn (±£5bn). Simultaneously, the Treasury has also suspended the ‘Value Indicator Target’ (essentially a value for money yardstick) for a further three months to the end of September.

The NS&I increased funding target is partly an acknowledgement of reality – in the first three months of 2020/21 NS&I raised a net £14.5bn. NS&I is currently offering table-topping interest rates (e.g. 1.16% AER for Income Bonds, and a 1.40% prize rate on Premium Bonds). The suspension of the Value Indicator Target reflects the fact that it would be markedly cheaper for the Treasury – and better value for the taxpayer – to sell more short-dated gilts. For maturities of up to five years, yields are negative.

NS&I looks set to be dominant in the savings market in a way that it has not been for some years. The decision to allow this is probably more political than financial.

Source: HMT News story: HM Treasury announces update to 2020-21 government financing targets – dated 16 July 2020

UK dividend payments fall sharply

(AF4, FA7, LP2, RO2) 

UK dividends plummeted in the second quarter and may take some years to regain ground.

Source: Link Asset Services

We have commented earlier that UK dividends were set to fall sharply. Quite how sharply has now been revealed in the latest quarterly dividend monitor from Link Asset Services:

• Total dividends paid in Q2 2020 were 57.2% less than for the corresponding period in 2019. If special dividends are excluded – and pre-pandemic these were expected to fall anyway – the decline in regular dividends is 50.2%. In hard cash terms, investors received a reduction of £22bn in their Q2 income.

• The financial sector accounted for half of the fall in regular dividends. The big four UK banks (Barclays, HSBC, Lloyds and RBS) and Standard Chartered all suspended their final dividends, after some persuasion from the Bank of England. The non-payment by HSBC, which is arguably more an Asian than a UK bank, accounted for about £3.4bn of reduced dividend income.

• We commented back in April on the vulnerability of oil company dividends and shortly afterwards Royal Dutch Shell confirmed the widespread concerns by cutting its quarterly dividend by 66% and stating that 16c, rather than 47c, would be its new base level for payments. Shell’s move alone was another £2.2bn of lost Q2 income. BP held their dividend, but all eyes are now on their corporate Q2 results, due in mid-August.

• 90% of consumer discretionary companies (retail, housebuilding, etc.) cancelled payouts completely.

• Link’s research revealed that, overall, 176 companies cancelled payouts and a further 30 cut them. Together that represented three quarters of Q2 payers. The unprecedented nature of the cuts is highlighted by the fact that 124 companies rescinded dividends previously promised.

• Dividends from the top 100 companies fell by 45% in Q2, compared with 76% for the more domestically-oriented mid-caps.

• There is little doubt that some companies have used the pandemic as cover to carry out an overdue rebasing of their dividend payment levels.

• Link’s future view of 2020 dividends (see graph above) is that:

• In the best case, payouts will fall by 39% on an underlying basis, or 45% down in headline terms (i.e. including special dividends).

• In the worst case there will be a fall of 43% on an underlying basis, or 49% on a headline basis.

For 2021 Link envisages a likely rebound of as much as 29%, year-on-year.

2019 will prove a highwater mark for dividend payments for some years. Link’s estimate is that it may not be until 2026 that dividends return to the level of last year.

Source: Link Asset Services July 2020