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Turmoil Returns to the U.K. Bond Market Turmoil Returns to the U.K. Bond Market
(about 2 hours later)
British financial markets plunged into turmoil on Wednesday following mixed messages over whether the Bank of England would continue to provide support to pension funds and other investors, introduced after a bungled policy announcement by the new government last month shocked investors.British financial markets plunged into turmoil on Wednesday following mixed messages over whether the Bank of England would continue to provide support to pension funds and other investors, introduced after a bungled policy announcement by the new government last month shocked investors.
The uncertainty led to a rapid sell-off in British government bonds. The yield on the 30-year government bond, or “gilt,” rose more than 0.2 percentage points on Wednesday, a big move for an asset that usually moves in hundredths of a percentage points. The yield pierced 5 percent for the second time in a month, resuming a sell-off that has taken its yield from just 3 percent at the start of September. Yields rise when bond prices drop. The uncertainty led to a rapid sell-off in British government bonds. The yield on the 30-year government bond, or “gilt,” rose more than 0.2 percentage points on Wednesday, a big move for an asset that usually moves in hundredths of a percentage points. The yield pierced 5 percent for the second time in a month — resuming a sell-off that has taken its yield from just 3 percent at the start of September — before easing back to roughly where it started the day. Yields rise when bond prices drop.
The immediate cause of Wednesday’s sell-off was tied to messaging from the Bank of England’s reiterating its plan to shut down its bond-buying program on Friday. Investors are nervous that the central bank is pulling out too fast, before the market and policymakers fully understand the causes that led to the initial sell-off last month. The immediate cause of Wednesday’s sell-off was tied to messaging from the Bank of England reiterating its plan to shut down its bond-buying program on Friday. Investors are nervous that the central bank is pulling out too fast, before the market and policymakers fully understand the causes that led to the initial sell-off last month.
The situation became murkier after The Financial Times reported that the Bank of England had told market participants that it could extend its intervention in the market beyond Friday. The central bank denied it.The situation became murkier after The Financial Times reported that the Bank of England had told market participants that it could extend its intervention in the market beyond Friday. The central bank denied it.
“It’s pretty extraordinary,” said Jeremy Lawson, chief economist at the asset manager Abrdn. “I don’t know anybody, regardless of how experienced they are in markets, that could have forecast everything we have seen happen.”“It’s pretty extraordinary,” said Jeremy Lawson, chief economist at the asset manager Abrdn. “I don’t know anybody, regardless of how experienced they are in markets, that could have forecast everything we have seen happen.”
The volatility started last month after the government led by Liz Truss, the new prime minister, announced a plan to revive the economy that included a package of tax cuts and plans for a cap on energy prices. The proposal to lower taxes has since been withdrawn, but it caused panic in the markets as investors worried about how the government would fund those new policies. That set in motion a domino effect through markets that rippled through the pension fund industry and eventually forced the central bank to intervene.The volatility started last month after the government led by Liz Truss, the new prime minister, announced a plan to revive the economy that included a package of tax cuts and plans for a cap on energy prices. The proposal to lower taxes has since been withdrawn, but it caused panic in the markets as investors worried about how the government would fund those new policies. That set in motion a domino effect through markets that rippled through the pension fund industry and eventually forced the central bank to intervene.
Investors were initially concerned that the government would have to borrow a lot of money to carry out its plan. Those worries tanked bond prices, and yields — which are indicative of the cost of borrowing for the government — rose.Investors were initially concerned that the government would have to borrow a lot of money to carry out its plan. Those worries tanked bond prices, and yields — which are indicative of the cost of borrowing for the government — rose.
This rapid rise in yields knocked into a sleepy corner of the British pension fund industry that is particularly sensitive to changes in interest rates and government bond yields. And those changes have an effect on the amount of money that so-called defined benefit pension plans have to pay out in the future.This rapid rise in yields knocked into a sleepy corner of the British pension fund industry that is particularly sensitive to changes in interest rates and government bond yields. And those changes have an effect on the amount of money that so-called defined benefit pension plans have to pay out in the future.
To protect — or hedge — against changes in interest rates, pension funds use complex financial contracts called derivatives. The value of these derivatives is tied to gilts. The initial sell-off in gilts in September, in response to the government’s tax cuts plan, was so fast and so sharp that the value of the hedges lurched downward. Because of the way the derivatives are structured, the drop in their value led to calls from market participants on the other side of those trades for more collateral to cover the losses.To protect — or hedge — against changes in interest rates, pension funds use complex financial contracts called derivatives. The value of these derivatives is tied to gilts. The initial sell-off in gilts in September, in response to the government’s tax cuts plan, was so fast and so sharp that the value of the hedges lurched downward. Because of the way the derivatives are structured, the drop in their value led to calls from market participants on the other side of those trades for more collateral to cover the losses.
Caught off guard by the speed of the move, pension fund managers began selling other assets, including gilts, to raise the cash needed to cover the collateral calls. Those sales only exacerbated the situation, driving gilt prices even lower.Caught off guard by the speed of the move, pension fund managers began selling other assets, including gilts, to raise the cash needed to cover the collateral calls. Those sales only exacerbated the situation, driving gilt prices even lower.
The sell-off compelled the Bank of England to step in to restore stability to the bond market, starting a short-term program to buy gilts on Sept. 28. At the time, the central bank said it would stop its purchases this Friday, which it hoped would give pension funds enough time to pull together the collateral and stabilize themselves.The sell-off compelled the Bank of England to step in to restore stability to the bond market, starting a short-term program to buy gilts on Sept. 28. At the time, the central bank said it would stop its purchases this Friday, which it hoped would give pension funds enough time to pull together the collateral and stabilize themselves.
However, the pension fund industry is typically slow moving, and the sale of assets, as well as the transfer of cash for collateral, can take time. Some asset managers said that as of last week, they still had pension fund clients pulling money out of their funds as they sought to raise more cash.However, the pension fund industry is typically slow moving, and the sale of assets, as well as the transfer of cash for collateral, can take time. Some asset managers said that as of last week, they still had pension fund clients pulling money out of their funds as they sought to raise more cash.
Aware that investors were still concerned about Friday’s deadline, the Bank of England announced on Monday additional support measures, including the purchase of inflation-linked bonds and a temporary facility that would provide short-term loans to banks in exchange for government bonds.Aware that investors were still concerned about Friday’s deadline, the Bank of England announced on Monday additional support measures, including the purchase of inflation-linked bonds and a temporary facility that would provide short-term loans to banks in exchange for government bonds.
As of Tuesday, the central bank had spent almost 7 billion pounds on bond purchases, far short of the potential £65 billion it made available for the life of the program. The central bank also spent almost £2 billion on inflation-linked bond purchases, part of Monday’s expanded provision where it said it would buy up to £5 billion per day for the rest of this week.As of Tuesday, the central bank had spent almost 7 billion pounds on bond purchases, far short of the potential £65 billion it made available for the life of the program. The central bank also spent almost £2 billion on inflation-linked bond purchases, part of Monday’s expanded provision where it said it would buy up to £5 billion per day for the rest of this week.
Satisfied that this should be enough, Andrew Bailey, the head of the central bank, said on Tuesday that the planned Friday deadline remained in place, directly telling pension funds that they had “three days left.”Satisfied that this should be enough, Andrew Bailey, the head of the central bank, said on Tuesday that the planned Friday deadline remained in place, directly telling pension funds that they had “three days left.”
The British pound slumped in value against the dollar on Tuesday evening. Trading on Wednesday opened with 30-year gilt yields rising above 5 percent, before the report in The Financial Times that suggested the bank could change its mind pulled the market back in the opposite direction.The British pound slumped in value against the dollar on Tuesday evening. Trading on Wednesday opened with 30-year gilt yields rising above 5 percent, before the report in The Financial Times that suggested the bank could change its mind pulled the market back in the opposite direction.
But as soon as the central bank reiterated its plan to pull back from the market on Friday, 30-year gilt yields again rose above 5 percent, setting up a volatile end to the week.But as soon as the central bank reiterated its plan to pull back from the market on Friday, 30-year gilt yields again rose above 5 percent, setting up a volatile end to the week.
“As the bank has made clear from the outset, its temporary and targeted purchases of gilts will end on 14 October,” the central bank said in a statement. The statement was followed by almost £4.4 billion of purchases, the biggest yet for a single day. Thirty-year gilt yields fell again, ending the day roughly where they started, around 4.8 percent.“As the bank has made clear from the outset, its temporary and targeted purchases of gilts will end on 14 October,” the central bank said in a statement. The statement was followed by almost £4.4 billion of purchases, the biggest yet for a single day. Thirty-year gilt yields fell again, ending the day roughly where they started, around 4.8 percent.
Part of the challenge for the central bank is that its short-term bond-buying program — which it installed to bring calm to the markets after the Truss government’s plans spooked investors — runs counter to its longer-term efforts to unwind pandemic-era bond purchases and raise interest rates. The goals are similar to those of other central banks as they seek to cool the economy and lower inflation.Part of the challenge for the central bank is that its short-term bond-buying program — which it installed to bring calm to the markets after the Truss government’s plans spooked investors — runs counter to its longer-term efforts to unwind pandemic-era bond purchases and raise interest rates. The goals are similar to those of other central banks as they seek to cool the economy and lower inflation.
Now, the government and the Bank of England are somewhat at odds, although there will be some clarity at the end of October, when the government will say more about how it intends to pay for its new policies.Now, the government and the Bank of England are somewhat at odds, although there will be some clarity at the end of October, when the government will say more about how it intends to pay for its new policies.
“I think the B.O.E. has been put in a very difficult position by the government’s actions,” Mr. Lawson of Abrdn said. “The first intervention it made was necessary. But we questioned at the time whether it was plausible to have such a short exit strategy.”“I think the B.O.E. has been put in a very difficult position by the government’s actions,” Mr. Lawson of Abrdn said. “The first intervention it made was necessary. But we questioned at the time whether it was plausible to have such a short exit strategy.”