Failed Bond Auction In The UK: Implications For Stock Markets

An ominous sign of a “failed” bond auction in the UK is going to drive investors away from weak currencies. Bloomberg reported that the UK Gilts had the first failed bond auction since 1995.

March 25 (Bloomberg) - U.K. gilts slumped after demand at an auction of bonds fell short of the amount offered, the first time the Treasury failed to attract enough bids at a sale of regular debt in 14 years. Investors bid for 1.63 billion pounds ($2.4 billion) of the 40-year securities, less than the 1.75 billion pounds of 4.25 percent notes slated for sale, the U.K. Debt Management Office said today in a statement from London.

“Basically it’s the first failed auction,” said John Wraith, head of sterling interest-rate strategy at RBC Capital Markets in London. “They didn’t receive enough to cover it all so the market has obviously sold off extremely heavily.”

The yield on the 10-year gilt jumped 10 basis points to 3.43 percent by 11:45 a.m. in London. The 4.5 percent security due March 2019 slipped 0.84, or 8.4 pounds per 1,000-pound face amount, to 109.02. The yield on the two-year note rose six basis points to 1.30 percent. Yields move inversely to bond prices.

The problem with all of this balance sheet pumping and expansion of debt, is that there are limits to how much can be done. When buyers of bonds start to get skittish and don’t step up to the plate, then yields will start to spike. It’s this spike in yields that will be a major negative for the stock market.

The Fed knows this and it’s why they’re embarking on the bond buying program. They need to support rates. The bond buying announced by the Fed last week was nothing more than interest rate support. The negative sentiment around the world should continue to help the US dollar. Currency is a zero sum game. If the EUR/USD is declining, then the USD/EUR is increasing.

If anyone still believes in “rational” valuations, then they know that the value of a stock is simply the discounted free cash flow less debt, divided by shares outstanding. The discount rate is a function of 10 year treasury rates. If this rate moves up sharply along with decreasing earnings, then stocks will be DESTROYED.

I don’t think that this market is trading on valuations presently. If investors were truly rational, then they would see that the systemic risk in the system, along with the implications for higher interest rates in the bond market, are setting the equity market up for one of the biggest collapses in history.

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