In the land of national debt the long bond is king

James Carville, an adviser to President Bill Clinton, once famously said that if he were to be reincarnated, he would like to come back as the US treasury’s long bond, because that was where the real power lay. For the last 12 years, since the end of the banking crisis, a born-again Carville would have been frustrated in the role. It seemed that governments could borrow as much as they liked, paying tiny, and in some cases even negative, rates of interest.

Not any more. In the UK, the equivalent of the long bond had the power to destroy the Truss government, and next week we will learn how much the bond markets are going to extract, in the form of higher taxes and public spending cuts, to pony up the billions the Sunak government needs to pay the bills. The omens are, at best, mixed. The prices of gilts, the UK government debt, have recovered from the post-Kwarteng panic, but they are miles away from the levels before his Budget.

To outsiders, this is a confusing market. Rather than quote the price of any given security, the measure is its inverse, the yield. This allows professionals to compare stocks with different coupons and different dates on which they are paid back. Since every stock has a redemption date, each day that goes past takes it a day nearer to repayment. Unless it is trading at exactly par (£100) that changes the yield to redemption, even if only by a tiny fraction of a per cent.

Typically, the changes in yield (up means the price is falling, and vice versa) are a few hundredths of one per cent, or basis point. In the convulsions of the Great Pension Fund Panic, the changes were measured in actual percentage points. Things have calmed down since then, but prices/yields remain volatile, depending on Mr Market’s view each day of the Chancellor’s announcement next week. Swings which would have been considered shocking are now daily occurrences. Triple lock to go? Yields slide as this signifies financial discipline at the Treasury. Triple lock to stay? More borrowing, and a failure to deal with difficult decisions. Yields rise.

Since bonds are repayable in the pounds of the day at some distant point in the future, inflation is a key influence on market prices. Today, the UK’s equivalent of the long bond yields about 3.5 per cent. Set against current inflation in double digits, that may not look particularly attractive, but inflation is a backward-looking indicator, while the bond yields are forward-looking. Some analysts argue that the monetary squeeze is already quite fierce, and will get fiercer if Bank Rate is raised again next month, as the market expects. In any case, it seems increasingly likely that the peak of inflation is very near, and as the eye-watering price rises in gas and food start to drop out of the rolling 12-month calculation, it will come down, perhaps dramatically.

The coming squeeze will hit all those assets which have ballooned in value in the zero-interest rate era, from shares to property, both commercial and residential. As prices of these assets fall, it’s quite possible that in a few months’ time, a government-guaranteed return of 3.8 per cent for 20 years will look quite attractive.

What’s a supermarket chain worth?

Britain’s supermarkets are disappearing from the view of quoted markets. Tesco is still there, and Sainsburys (for now, at least) but Morrisons, Asda, Aldi and Lidl are all privately owned. An indication of just why these shadowy shareholders value the businesses at so much more than the stock market was provided this week across the Atlantic.

In 2005 Cerberus, usually described as a secretive private equity business, bought 661 unwanted stores as the rump of a buy-out of 1700 stores in Albertsons, a supermarkets group. Cerberus put up $975m in equity. In the subsequent decade it bought a further 2,200, putting up $1.35bn of fresh equity. In 2020 Cerberus took the whole lot back to market, listing at an enterprise value of $26bn, having taken $2.6bn of dividends on the way.

Now, if the anti-trust authorities let them, the Cerberus boys plan to sell the whole shooting match to Kroger for an enterprise value of $24.6bn. As the FT reports, the profit on two decades-worth of grocery trading is “set to be worth an incredible $14bn in cash”. The key to this near-magical mechanism to turn two-and-a-half billion dollars into twenty-six has been to exploit the underlying property values.

This will hardly be a revelation to the new owners of Morrisons or Asda, which have taken on huge debts to fund their purchases. It does make you wonder, though, whether the market really knows how to value Tesco, and whether even the UK’s biggest supermarket group is not too big for an ambitious private equity raider.

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