MNI INTERVIEW: Linkers Poor Value Funding - Swedish Debt Head
MNI (LONDON) - The move by the Swedish Debt Management Office to reduce its relatively high proportion of inflation-linked gilt issuance to more typical international levels comes as linkers have become a more expensive form of funding lacking structural demand, its Head of Debt Management Klas Granlund told MNI.
The Riksgalden is also switching to single price from multiple price linker auctions, a move which Granlund said has been well received given high levels of market uncertainty. If the new auction system is successful it could be extended to nominal bonds, he said, though he added that there were currently no plans to do so.
Detailed analysis of linker issuance indicated that it provided no cost benefit, and that the category lacked structural demand, he said.
“At times, it has been sort of neutral, but over the past few years, it actually indicated that it is quite expensive funding for us. When we included in our analysis the risk aspect it seems to be, according to our simulation models, that index-linked bonds do actually increase slightly the risks ... of the portfolio," Granlund said in an interview.
LESS LIQUID
"Linker bonds will never be as liquid as nominal bonds ... So then the question becomes, are investors willing to pay you ... the option premium for providing the inflation protection to them? In the Swedish case, it's quite obvious that they are not willing to pay that in excess of the different liquidity premiums. So in Sweden, I guess we don't have that type of structural demand at current outstanding volumes," he said.
Following a recommendation by the DMO, the government ditched a target for 20% of debt to be in linkers and instead adopted a notional target to reduce the volume of linkers to SEK80 billion by end 2029 from SEK177 billion.
Linker issuance is expected to total SEK6 billion per year from 2025, down from SEK9 billion in 2024, according to the DMO's borrowing report. This was nonetheless above the SEK4 billion analyst consensus.
"The reason to move to a notional target is because we do not have control of the size of the government debt, and we don't have control of inflation," Granlund said, adding "it depends where the debt is, of course, in 2029 but given a fairly stable debt, it will be around eight, 10% of debt anyway. And that is fairly in line with other countries."
SINGLE PRICE EXPERIMENT
Single price auctions, which give all successful bidders the same purchase price, are used for linkers in the UK and elsewhere and for some nominal bonds in the U.S.
"It is quite obvious that the index-linked bonds are suffering from price uncertainty. And as we show in the commentary, single price auctions are better suited in a market with high uncertainty," Granlund said, noting that the Riksgalden’s analysis of bid spreads in multi-price linker auctions published last week indicated “a not very well functioning market and quite a large uncertainty around where the actual price in the market is.”
The reaction to single price auctions has been positive, he said.
"In Sweden, we have not used this format, so it is quite new to people. They have a few questions about how it works. But overall, I think they all understand the concept of reducing the winners’ curse ... which is the purpose of a single price auction. So giving them a bit more confidence to bid in the auction without the risk of having to place a bid that is completely too low in yield terms or high in price terms, will mean that hopefully participation in our auctions will increase.”