Why did the Bank of England say it would buy government bonds only a week after announcing plans to sell them?
The central bank said it acted on a financial-stability basis. And it targeted support at the long end of the maturity curve. “Were this market lax to continue or worsen, there would be a material risk to the financial stability of the UK. This would lead to an unnecessarily tightening of funding conditions and a reduction in the flow of credit to the real economy,” the Bank of England said. Will come
The Bank of England did not delve into the details. But the focus on the long end – that is, buying only bonds with maturities of at least 20 years – points to two specific problems.
What to do with the pension fund first. They are not wild speculators by nature. But they are big users of both interest rate derivatives and swaps. A report by the pension regulator said that nearly two-thirds of the UK’s top 600 pension funds were users of interest rate swaps. Publication Risk said some were hit with margin calls of £100 million due to dives in both Gilt and Sterling.
It is also worth noting what pension funds use as collateral on these derivative positions – gilts. A margin call therefore forces them to sell the gilt, which is ultimately to cover the loss from a fall in the gilt.
The Bank of England’s actions had immediate consequences, with a return on the 30-year gilt TMBMKGB-30Y,
Diving over 100 basis points.
“This probably mitigates the tail risk of endless stop outs leading to higher real yields,” said Orla Garvey, senior fixed income portfolio manager at Federated Hermes.
The second issue made more headlines in the UK media. Mortgage providers were collectively withdrawing the products. They are also big users of interest-rate swaps. Those swap rates were, in turn, affected by swings in the gilt market.
However, the mortgage issue has not been resolved immediately. Mortgage rates in the UK tend to be more tied to the shorter end of the curve, which in turn is very sensitive to interest rates set by the Bank of England. Markets are currently pricing in rate hikes on the order of a full two percentage points at the November meeting, and rates will peak at 6%.
“A policy rate closer to 6% would raise the average mortgage payment by more than 50% from a year ago level. This would be an unprecedented hit to household income, which businesses and consumers already have energy for,” said Barclays strategists. A rise in prices is visible, and all will ensure a deep recession.
Credit: www.marketwatch.com /