M&G’s Jim Leaviss: Today’s BoE intervention on gilts to mitigate govt damage is “not a good look”

by | Sep 28, 2022

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Following today’s intervention from the Bank of England(BoE), Jim Leaviss, CIO of public fixed income at M&G Investments comments:

“After Friday’s mini-Budget in the UK sent the pound plummeting and government bond (gilt) yields higher, stresses in the UK pension market became so severe that the Bank of England has been forced to step in and announce a gilt buying programme.  They will be buying long dated gilts, starting today with up to £5 billion, in a reverse auction process.  Of course, the very announcement of such support has been enough to send gilt yields down significantly, with 30 year gilts, which approached 5% yesterday, down nearly 1.1% in yield to below 4%.  The impact of such yield changes on price is extreme for these long duration assets.  The 30 year gilt (1.25% 2051) is up nearly 11 points from last night’s close.  In the days since the mini-Budget it had fallen from around a price of 60 to just over 40 (pence in the pound).  Current price = 54.20.”

Why has the Bank intervened?  https://bondvigilantes.com/blog/2022/09/collateral-calls/

“Pension funds have found themselves short of liquid collateral to pay to counterparties with which they have taken our interest rate or inflation swaps.  As yields rose as a result of Friday’s announcement of unfunded tax cuts for the rich (and therefore expectations of more government bond issuance) pension funds with these LDI (Liability Driven Investment) swaps found themselves having to post collateral to cover mark to market losses.  And therefore some had to liquidate other investments to do so – including gilts, sending yields up further and exacerbating the problem.  This is purely a liquidity problem – PFs are solvent, and indeed for many of them higher yields actually reduce their funding deficits and would be good news in a less extreme scenario.”

“What could the Bank do?  They were frightened that this could become a systemic problem (‘a material risk’) for the UK economy (a financial stability issue).  They have not talked about the impact of higher yields on economic activity, but obviously higher gilt yields feed through into higher borrowing costs for households and businesses too.  They are keen that this is seen as an operation to reduce strains in a particular market – not a reopening of Quantitative Easing!  But like it or not, it will loosen monetary policy, at a time where Hugh Pill (Bank Chief Economist) is talking up the chances of more rate hikes to dampen the inflation impact of the mini-Budget.  The money markets still price in 1.75% of Bank hikes at the next MPC meeting in November – the yield curve is therefore very inverted, with short dated yields higher than long dated yields.  Gilt sales from the Bank’s balance sheet – Quantitative Tightening – have been postponed until the end of October, although it still plans to sell £80 billion of gilts over the next year.”

“The Bank of England having to intervene to mitigate the damage done by the government is not a good look.  The IMF – traditionally raising its eyebrows at emerging markets finance ministers – took the unusual step of criticising UK policy last night.  We have the rating agencies also waiting in the wings, and a credit rating downgrade is a possibility too.  All eyes are now on speeches from the new PM and Chancellor at the imminent Conservative Party conference – there is a fear that there is nothing they can say that won’t make things worse.”

Find out what other investment experts have been saying about today’s intervention here

 

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