UK bond market moves are dramatic and analysts think it could get worse

LONDON — British bonds have sold off again this week, pushing yields to their highest level since before the bank of englandis historical intervention to avoid the collapse of a pension fund late last month.

Monday’s sharpest moves were centered in the market for index-linked gilts – illiquid bonds where payments to bondholders are benchmarked in accordance with the UK retail price index.

The magnitude of the rise in bond yields — which move inversely to prices — prompted the Bank to expand emergency bond purchase program Tuesday to include indexed gilts up to Friday’s deadline. In a statement, the Bank said the malfunctioning of the index-linked gilt market posed a “significant risk to the financial stability of the UK”.

The Bank’s first temporary rescue measures on September 28 were launched after warnings from liability-driven investment funds (LDIs) that they faces imminent collapse following the capitulation of UK long-term government bond prices.

Yields cooled slightly after Tuesday’s expansion of the buying program to capture pegged gilts, which followed a decision on Monday to raise the daily limit for gilt purchases, but remained close to levels seen before the first. Bank intervention.

Analysts generally expect volatility to continue in the coming weeks, at least until the decisive fiscal policy announcements by Finance Minister Kwasi Kwarteng on October 31. Kwarteng announced on Monday that the medium-term fiscal plan would be brought forward three weeks from its scheduled date as the Treasury seeks to allay market fears.

Initial announcement of Kwarteng’s “mini-budget” on September 23 sent markets into turmoil and was widely criticized for its panoply of debt-financed tax cuts aimed at high earners and businesses, with the government saying its plan would spur economic growth.

Give way “in one direction”

Also on October 31, the Bank of England plans to begin its delayed sale of gilts as part of a broader quantitative tightening effort and the unwinding of pandemic-era monetary stimulus. The Monetary Policy Committee will not meet again until November 3, after the expected resumption of gilt sales.

Several strategists attributed the continued jitters in bond markets, despite the Bank’s efforts, to the limited duration of its intervention and the prospect of a resumption of gilt sales. Others pointed to uncertainty over the government’s ability to restore credibility with its end-of-month fiscal policy projections.

Stuart Cole, chief macroeconomist at brokerage Equiti Capital, said the Bank of England’s sequence of announcements since its initial intervention may suggest it is beginning to “lose control” of the gilt market.

“He needs to tighten policy to try to get inflation under control, but at the same time he’s going into what is, in effect, another round of quantitative easing, and so far we haven’t really had signs from the government that it is considering rolling back more of the measures announced in late September,” Cole told CNBC via email.

“The market smells of blood and considers that if the BoE sticks to its plans and ceases its intervention this week, then with no response expected from the government, and with pressure on the BoE to raise rates with more strength at the November meeting At the MPC meeting, returns will only go in one direction.”

Based on analysis of the Bank of England’s bond purchases so far, RBC strategists stressed in a note Tuesday that the program is not designed to depress yields, but rather to offer investors who are desperate to sell a way to do so.

“This is not the same focus as with the original ‘QE’ programs where the BoE entered the market with a big target and actively influenced the price. This should give us pause for weeks to come” , said Peter Schaffrik, RBC Global Macro Strategist. .

Martin Weale says to save the UK economy a spending cut or rollback of tax cuts is likely to come

“If the market is already increasing yields aggressively with the BoE in the market on the buy side, how will the market handle an active QT program, where a predefined size will need to be pushed into the market?”

Because of this, RBC said there was a “strong possibility” that the Bank of England would reconsider whether to continue with its quantitative tightening programme, which is due to start on October 31 and target £80bn (88 $.8 billion) in annual gilt sales.

Schaffrik suggested that the conflicting dates of the government’s medium-term budget plan and forecast and the start of the Bank’s QT program could provide the central bank with a hedge to delay the start and allow the MPC to assess the reaction of the Treasury plan market.

The next few days will be a “roller coaster”

Thanks to its relatively lukewarm response to inflation at the start of the year, some economists believe the Bank laid the groundwork for the volatility and illiquidity currently plaguing the UK bond market.

James Athey, chief investment officer at Abrn, noted on Tuesday that the Bank’s decisions are now heavier, as a lack of aggressiveness will be perceived as weakness by the market, while an overly exuberant reaction could be interpreted as the panic.

“Their recent attempts to deal with weakness and volatility in UK asset markets, ably aided by the pernicious impact of excessive and reckless leverage in the LDI sector, are mere band-aids,” Athey said.

“As always, the maxim will hold true – there is nothing so permanent as a temporary government program and the risk for the Bank is that it has already become trapped in a program of asset purchases at a when his mandate dictates that he withdraw cash to tighten policy.”

As the looming deadline for temporary gold purchases draws closer, with neither market weakness nor volatility having “significantly diminished”, Athey suggested the next few days would likely be a “roller coaster”, regardless of what the Bank would ultimately decide to do.

Leave a Comment

Your email address will not be published. Required fields are marked *