UK Treasury Bill Issuance Not a Savior for Gilts, Limited Financing Cost Savings

Overview

This report analyzes the measures announced recently by the UK Debt Management Office (DMO) regarding Treasury Bill (T-bill) issuance and their impact on the UK Gilt market. Goldman Sachs believes that while increasing T-bill share can lower average financing costs, the savings magnitude is relatively limited, and it would increase financing volatility, therefore T-bill issuance is not a 'panacea' for resolving Gilt market pressure. The core conclusion of the report is: Increasing T-bill share has limited compression effect on Gilt risk premium; a more effective path is through enhancing confidence in low and stable inflation.

Core views

Current status and potential of UK T-bill usage: Historically, UK T-bill issuance share has been low compared to G10 markets, fluctuating between 0-5% of GDP over the past few decades, currently around 3%, while the G10 average is about 10%. T-bills are mainly used for cash management to smooth government cash position fluctuations, rather than debt management. Structurally raising the T-bill share to 10% means T-bills will play a larger role in debt management, substituting some Gilt issuance. Trade-off between Financing Costs and Volatility: Increasing T-bill share can reduce the weighted average maturity (WAM) of debt; in an environment where the yield curve is typically upward sloping, this can lower average financing costs. Goldman Sachs estimates that raising the T-bill share to 10% (corresponding to approx £296 billion T-bills, current outstanding £94 billion) could save approx 5bps annually (£1.4 billion) under the current yield curve, and approx 10bps annually (£2.8 billion) under the 20-year average yield curve. At the same time, short-end interest rate volatility is higher than long-end; lowering WAM increases financing volatility, impacting budget planning. Since 2021, average interest cost revisions in OBR budget forecasts have reached £10 billion, while fiscal space averages only £16 billion, showing significant impact of interest cost volatility on budget planning. Demand-side Analysis: Banks are currently the largest holders of UK T-bills (approx £27 billion held by banks and financial institutions out of the £94 billion outstanding), but recent data shows banks prefer mid-curve Gilt maturities. Households face tax disadvantages when holding T-bills directly (Gilts and tax-advantaged savings accounts ISA enjoy more favorable tax treatment) and liquidity frictions. Money Market Funds (MMF) are small in scale in the UK (approx £240 billion at end of 2023), with low T-bill holdings, contrasting with US MMFs holding over 30% of the $6.6 trillion T-bill outstanding. Foreign official holdings and stablecoins may be potential demand sources, but pound reserve allocation has been flat in recent years; stablecoin demand depends on the UK regulatory environment. Market Impact: Raising T-bill share has mild supply benefits for long-dated Gilts; transitioning to a 10% share could reduce free float of Gilts by approx 5 percentage points, corresponding to a swap spread tightening valued at 5-10bps via swap spread model. However, the macro impact on Gilt risk premium is limited; financing volatility is also a key consideration for fiscal dynamics and risk premium pricing. At the money market level, T-bill-OIS spread is determined more by financing conditions than T-bill supply levels.

Analysis framework

The report uses a debt management framework to analyze the issuance structure trade-off between T-bills and Gilts. Core logic is WAM (weighted average maturity) management trade-offs between financing costs and financing volatility. The report first compares UK T-bill share with other G10 markets to establish the benchmark for UK's relatively low T-bill usage. Then, through yield curve morphology analysis of short-end vs long-end interest rate cost-volatility characteristics, quantify the financing cost savings from increasing T-bill share. Demand-side analysis evaluates potential buyers and constraints from multiple dimensions including banks, households, MMFs, foreign official entities, and stablecoins. Market impact analysis combines swap spread models and T-bill-OIS spread historical data to assess the impact of T-bill supply changes on Gilt curve and money markets. The report also cites experience from the high interest cost period in 2022-23, explaining how a combination of short-maturity debt and inflation-linked debt exacerbates interest cost volatility during high inflation periods.

Methodology notes

• Company Fundamentals & Financial FrameworkOperating/Financial Leverage Analysis

  Debt Maturity Structure Management (WAM Management)

  Weighted Average Maturity (WAM) is a core indicator for debt management. Shortening WAM (increasing short-debt share) can lower average financing costs under an upward-sloping yield curve, but short-end interest rate volatility is higher, increasing financing volatility risk. This is a classic cost-risk trade-off in debt structure decisions.

• Fixed Income & Credit AnalysisSpread analysis

  Swap Spread and T-bill-OIS Spread Analysis

  Swap spread reflects pricing difference between government bonds and interest rate swaps; T-bill-OIS spread reflects pricing difference between short-term treasury bills and overnight index swaps. The report uses these two spreads to analyze the impact of T-bill supply changes on bond market pricing, finding that financing conditions are more critical than spread levels.

• Industry/Industrial Analysis FrameworkSupply-demand framework

  Government Bond Market Supply & Demand Analysis

  The report analyzes the UK government bond market bidirectionally from supply side (issuance structure of T-bills and Gilts) and demand side (preferences of holders such as banks, households, MMFs, foreign officials). Increasing T-bill share reduces long-dated Gilt supply, but demand is constrained by factors such as taxes, liquidity, and leverage calculations.

• Cycle & Business Outlook FrameworkBusiness Turning Point Analysis

  Yield Curve Morphology and Issuance Timing Selection

  The report points out that WAM should be managed across cycles: extend issuance WAM when curves are steep and front-end/back-end rates are below historical norms; shorten WAM when inverted or flat and rates are elevated due to cyclical factors, to avoid locking in historically high long-end yields. This is the logic for timing selection of debt issuance.

Key data

• UK T-bill Share (Current)Approx 3%Far below G10 average of approx 10%
• UK T-bill Outstanding£94 billionCurrent outstanding amount
• Stock Corresponding to 10% T-bill ShareApprox £296 billionScale required to reach G10 average level
• Financing Cost Savings (Current Curve)Approx 5bps/yearApprox £1.4 billion
• Financing Cost Savings (20-Year Avg Curve)Approx 10bps/yearApprox £2.8-3.0 billion
• Bank Holdings of T-billsApprox £27 billionHeld by banks and financial institutions out of £94 billion outstanding
• UK MMF ScaleApprox £240 billionFCA estimate at end of 2023
• Cash ISA BalanceApprox £450 billionContinuously growing in recent years
• Potential Swap Spread Tightening5-10bpsPotential impact of transition to 10% T-bill share
• Average OBR Interest Cost Revision£10 billionSince 2021 vs avg fiscal space of £16 billion

Impact & implications

Regarding the UK gilt market, increasing T-bill share has mild supply benefits for long-dated Gilts, reducing free float of Gilts by approx 5 percentage points, but insufficient to significantly compress Gilt risk premium. The report believes the path to substantive decline in Gilt risk premium is through enhancing confidence in low and stable inflation, rather than issuance term structure shifts. Regarding money markets, increased T-bill supply may lead to relative cheapening of T-bills, but T-bill-OIS spreads are more determined by broader repo financing conditions than T-bill outstanding levels. Long-term, more T-bills may shrink Bank of England balance sheet size by reducing reserve requirements, but this does not necessarily affect BoE Gilt holdings. For investors, the report highlights that financing volatility is a key consideration for fiscal dynamics and risk premium pricing; interest cost volatility significantly impacts budget planning; attention should be paid to T-bill issuance rhythm and changes in market demand.

Risks

• Increased Financing Volatility: Short-end interest rate volatility is higher than long-end; lowering WAM increases financing volatility risk, impacting budget planning
• Demand Uncertainty: Banks prefer mid-curve Gilt maturities; households face tax disadvantages when holding; MMFs are small in scale in the UK
• Limited Risk Premium Compression: Increased T-bill issuance has limited compression effect on Gilt risk premium; more dependent on inflation confidence
• Regulatory Constraints: Stablecoin demand for T-bills depends on UK regulatory environment and end-user demand for GBP-denominated stablecoins

What to watch

• DMO T-bill issuance rhythm and implementation of weekly 12-month T-bill auctions
• Changes in T-bill share and reduction magnitude of Gilt free float
• Changes in bank and MMF holdings of T-bills
• Trend of T-bill-OIS spreads and swap spreads
• Bank of England balance sheet size and changes in reserve requirements
• Inflation expectations and Gilt risk premium changes