Early this morning (around 5 a.m. central) Bank of England announced a ‘temporary’ return to quantitative easing and suspension of asset sales.
BOE said the markets had become dysfunctional and their intent was to stabilize markets.
Both equities and interest rates immediately turned higher (in price) in the U.S. – whether this holds is anyone’s guess. At this moment (5:30 am central) the S&P500 is off just a bit and the DJIA is flat (from off 280 Dow ponts). The 10 year treasury is at 3.88%–down 8 basis points.
Like everyone else including the Bank of England (The UK version of the Federal Reserve), I am shocked at how badly this went. Last Friday, the Chancellor of the Exchequer, Kwasi Kwarteng, announced new interest rate and tax policies. Apparently, they had NO idea of the ramifications in doing this. We all knew that the markets were NOT happy, with the British Pound suffering dramatic losses and their Long “Gilts” aka 10 year bond rates rising dramatically.
Kwasi was meeting with the heads of the major banks this morning (Tuesday) in London. They must have read him the riot act. One observer claims they came close to a “Lehman moment” which as we all know is beyond serious, bordering on catastrophic.
Further comments from another FT article:
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The bank stressed that it was not seeking to lower long-term government borrowing costs. Instead it wanted to buy time to prevent a vicious circle in which pension funds have to sell gilts immediately to meet demands for cash from their creditors.
That process had put pension funds at risk of insolvency, because the mass sell-offs pushed down further the price of gilts held by funds as assets, requiring them to stump up even more cash.
“At some point this morning I was worried this was the beginning of the end,” said a senior London-based banker, adding that at one point on Wednesday morning there were no buyers of long-dated UK gilts. “It was not quite a Lehman moment. But it got close.”
The most directly affected groups were final-salary pension schemes that have hedged to ensure their ability to make future payments — so-called liability-driven investment strategies that are very sensitive to fast-moving gilt yields.
“It appears that some players in the market ran out of collateral and dumped gilts,” said Peter Harrison, chief executive of Schroders, which has $55bn in global LDI business. “We were more conservatively positioned and we had enough collateral to meet all of our margin calls.
Link to article:
https://www.ft.com/content/756e81d1-b2a6-4580-9054-206386353c4e
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If UK pension funds starting missing margin calls, it would spill over to ALL of the money center banks in about a nanosecond. Don’t think for that nanosecond that the US would have been spared. All of the Too Big to Fail US banks would have been involved. Whether they would have required another Fed backstop like in 2008 is unknowable, but sounds like it was possible.
In the meantime, markets are up, everybody is happy, excepting Floridians, so all must be well. (Strange side note: we sold our Florida house a few months back, avoiding both the hurricane and 7% mortgage rates. We expected the rate increase, not all the way to 7%, but did NOT plan on the hurricane. Pure luck of timing.)
Tex,
Thanks for the links. Most interesting discussion I have seen in a long time on III.
I want to bring something else to the table regarding the market, Fed Policy and world financial markets. For a long time America has seen itself insulated from what else goes on in the world. This link to an article by Market Insider may not work.
https://markets.businessinsider.com/news/currencies/china-bank-dollar-yuan-currency-markets-economy-beijing-fed-hike-2022-9
China’s response to Fed’s raising rates in a slowing world economy and in China is to support the Yuan.
This may be the start of something big.
Telling banks in China and overseas to sell assets and build up dollar reserves to then sell dollars to buy Yuan to support its value.
How this will affect our stock market is beyond me unless someone else has access to reports on what percent of the world market the Chinese own of stocks.
If this first attempt at support doesn’t hold then would they start to sell Treasuries to accumulate dollars?
As an aside, back in the late 80’s and early 90’s Japanese companies had been accumulating US real estate with all their dollars. All of a sudden, they hit a liquidity crisis and started selling housing developments, shopping malls, country club golf courses etc.
Maybe similar to China’s real estate developers today who wanted to move assets overseas only now needing to sell those same assets.
Not sure how accurate this is but I read this from a financial reporter on Twitter and would explain the BOE decision
On the @bankofengland intervention:
Am told the BoE were responding to a “run dynamic” on pension funds – a wholesale equivalent of the run which destroyed Northern Rock.
Had they not intervened, there would have been mass insolvencies of pension funds by THIS AFTERNOON.
Mav:
Not surprising that the UK pension funds became vulnerable. Powell and his merry band of clowns at the Fed still probably believe their super aggressive “Tough Guy” rate policies can be turned on like a faucet with no repercussions anywhere else in the world.
Eventually you will likely see Powell issue a similar “mea culpa” statement to the one issued below by the BOE today. Just substitute “U.S.” and “Federal Reserve” for “UK” and “BOE”.
“Were dysfunction in this market to continue or worsen, there would be a material risk to U.K. financial stability. This would lead to an unwarranted tightening of financing conditions and a reduction of the flow of credit to the real economy,” the Bank of England said in a statement. “In line with its financial stability objective, the BoE stands ready to restore market functioning and reduce any risks from contagion to credit conditions for U.K. households and businesses.”
I assume “run dynamic” is some fancy pants term to describe not enough money to pay immediate liabilities which causes a loss of faith with people somehow wanting to take money out of their pension which I did not realize was allowed as a pension is a set amount paid over time? Not something where you can take out whatever amount you want at the drop of a hat. With that said maybe there are agreements allowing loans against future payments or what not.
Northern Rock basically ran into that combined with a run on the bank once people realized something was off. The bank had a lot of assets but no liquidity during the GFC or the liquidity came to late from the govt.
I am not sure why they create these terms instead of speaking plain english.
Interesting read on Northern Rock Bank history. Another footnote from the GFC. Not sure what is meant by pension funds but back during the Brexit a rush to remove funds caused life insurance companies, banks and mutual funds to freeze withdrawals
https://qz.com/723883/british-funds-are-freezing-withdrawals-reviving-scary-memories-of-the-global-financial-crisis/
People might not be aware, but because of the run here on withdrawals from MM funds the SEC ? passed a ruling that the funds can freeze for 7 days withdrawals. This didn’t prove sufficient as our government twice had to step in to back the funds in the past 12yrs
sound familiar?
https://www.reuters.com/markets/us/why-is-us-securities-regulator-proposing-new-rules-money-market-funds-2021-12-15/
Makes me think I should cash in the Met Life policy I inherited
I had the time to read a ft article and a few other places. Basically the pension funds were forced to sell long dated bonds because they needed more collateral for margin calls. This forced the yields to go up and thus more selling for more margin calls. Basically a loop since they are so large. Pension funds can move the market easily as a group.
Thus the central bank had to buy buy buy.
I had a feeling this would break soon. I just don’t think it is enough of a break for the fed yet.
“Basically the pension funds were forced to sell long dated bonds because they needed more collateral for margin calls. This forced the yields to go up and thus more selling for more margin calls”
I’d question this interpretation. Pensions are not usually leveraged investors, so they wouldn’t get a margin call. They normally invest in a mix of equities and longer term bonds, and hope the returns on those are enough to meet their promised future pension payouts. If not, they might have to pay people only $0.80 on their promised dollar or something if investment returns are poor, but they won’t get margin calls because (at least nearly all of them) aren’t borrowing to invest. Even those few who are making the questionable choice of borrowing to try to enhance returns (since fixed income was paying nothing under the Fed’s low rates for many years) were only borrowing a little. Calpers was 105% long, only borrowing 5%. You’re not going to get a margin call on that.
https://www.forbes.com/sites/simonmoore/2021/11/16/major-pension-fund-adds-leverage-as-assets-push-half-a-trillion/?sh=4276d57a27e1
https://www.ft.com/content/038b30c3-f550-4cc0-93ed-9154021d6ee2
“This 2019 Pensions Regulator report that looked at the top 600 UK pension schemes, with total assets of around £700bn. It found that “the notional principal of schemes’ leveraged investments totalled £498.5 billion; interest rate swaps were held by 62% of schemes and accounted for 43% of all leveraged investments” and that “The maximum permitted level of leverage ranged from 1x to 7x”.
Many schemes using derivatives like interest rate swaps will just be smoothing out cash flows, but a good portion will be gaining exposure to long interest rate risk through these derivatives. They will essentially be buying long fixed and paying floating. When you’re deploying leverage you need to think about your collateral — essentially initial margin plus variation margin.
This, again from the 2019 Pensions Regulator survey of the top 600 schemes, asks what method they were using to monitor collateral. Schemes use a variety of ways. I’ve highlighted basis points to exhaustion because it seems pretty intuitive: how many basis points rise in yields before your collateral is gone. The answer back in October 2019 was 291 basis points.
Long yields have since risen by 400 bps.”
So maybe not leverage as I think of it. Like I borrow money to buy stock. But the article sure makes me think they are using leverage and require collateral to cover their borrowings.
https://www.ft.com/content/038b30c3-f550-4cc0-93ed-9154021d6ee2
“This 2019 Pensions Regulator report that looked at the top 600 UK pension schemes, with total assets of around £700bn. It found that “the notional principal of schemes’ leveraged investments totalled £498.5 billion; interest rate swaps were held by 62% of schemes and accounted for 43% of all leveraged investments” and that “The maximum permitted level of leverage ranged from 1x to 7x”.
Many schemes using derivatives like interest rate swaps will just be smoothing out cash flows, but a good portion will be gaining exposure to long interest rate risk through these derivatives. They will essentially be buying long fixed and paying floating. When you’re deploying leverage you need to think about your collateral — essentially initial margin plus variation margin.
This, again from the 2019 Pensions Regulator survey of the top 600 schemes, asks what method they were using to monitor collateral. Schemes use a variety of ways. I’ve highlighted basis points to exhaustion because it seems pretty intuitive: how many basis points rise in yields before your collateral is gone. The answer back in October 2019 was 291 basis points.
Long yields have since risen by 400 bps.”
So maybe not leverage as I think of it. Like I borrow money to buy stock. But the article sure makes me think they are using leverage and require collateral to cover their borrowings.
I wanted to follow up that I was wrong about pensions using margin. Apparently in the UK, nearly all of them do this due to something about how their accounting for future liabilities is done and they are long not just the bonds they would normally hold, but lots more on margin to smooth out this accounting risk. Of course avoiding the accounting risk gives rise to very real risks when rates rise and the value of your long bonds on margin fall, leading to possible cascading margin calls. I put together a few articles on this here if you’re interested.
https://www.fragiledeal.com/t/whither-bonds/4436/165?u=xerty
Let’s ask Charles Rex.
It seems the B.O.E. has “gilt tripped” bond traders. Lol.
I understand there are supply constraints for Bobblehead Queens.
Dilemma for Central Bankers- fight inflation and suffer market collapse and economic depression or push to stabilize social order, employment with higher asset prices with runaway inflation. Scary. QE has been going on for 12 plus years.
Lol! Why am I not surprised the BOE is bailing out Liz Truss’ policies?
“Lol! Why am I not surprised the BOE is bailing out Liz Truss’ policies?”
Interesting how yesterday, the anti-Democrat comment was deleted and the poster flogged, yet, this anti-Conservative comment is allowed to remain up for all to see and not a word was said.
Is there fairness across the board moving forward or just selective censorship as has been the rule in the past ?
I never said Liz Truss’ policies were good or bad. That’s up to each person to decide for themselves. But it is a fact that the run on gilts was triggered by the policy announcement.
Tex the 2nd describes the situation best in his comment:
“Like everyone else including the Bank of England (The UK version of the Federal Reserve), I am shocked at how badly this went. Last Friday, the Chancellor of the Exchequer, Kwasi Kwarteng, announced new interest rate and tax policies. Apparently, they had NO idea of the ramifications in doing this. We all knew that the markets were NOT happy, with the British Pound suffering dramatic losses and their Long “Gilts” aka 10 year bond rates rising dramatically.”
You don’t have to fully sharpen a pencil to make it have a definite point. Should have posted under the name Bea and then apologized for the drive-by lambasting. Perhaps that would have gotten it done.
“You don’t have to fully sharpen a pencil to make it have a definite point. ”
I have no idea what you’re saying. My only point was we shouldn’t be surprised at Central Bank bailouts of these policies.
Your accusation that the moderation on this website is biased is completely off base.
Thanks Landlord,
I want to move on.
I don’t know anything about GB politics so didn’t take the comment one way or the other.
My battery died at 6:30am WCT as I was debating a response so saved me the trouble
Preferreds–do I need to babysit 24/7? You don’t know my politics at all–you might be shocked.
It’s hard not to make a sarcastic comment!
Does prayer work with secular investing?
My wife picked up some NI-B yesterday, felt comfortable with it and 18 month reset.
PS Tim FYI: It’s on your sheet as a FtoFl, but it is an FRR. Databases are tough to keep up! Thanks for all the resources.
It is fixed to float..floats at 3.63 + US 5 year treasury after March 2024
Sumit, I think the accurate terms are as follows:
FTF – Issues that float based on a spread to the 3mLibor. Once they begin floating their dividend changes each quarter, based on the 3mLibor’s rate in effect on each succeeding dividend’s “Dividend Determination Date”.
EACH dividend “floats”.
FRR – Issues that reset based on a spread to the 5yrTreasury. Once the original coupon changes, the new dividend rate (5yrTreasury + spread) remains fixed for 5 years before it resets again.
We use the term FRR (“fixed rate reset”) for these issues, as the new rate is “fixed” for 5 yrs.
At least, that’s my understanding.
Picking nites but:
Are all FTFs tied to 3mL?
I know for a fact that not all FRRs are tied to 5yT. For example, Huntington’s Ser. F and Ser. G are tied to 10yT and 7yT respectively.
lol nits not nites
Thanks Joel–will check on it and correct.
I don’t see that the markets have become dysfunctional. They’re functioning just fine; they’re just dropping fast and hard. Maybe the problem is that the old lady of Threadneedle Street is becoming hysterical . First time she’s ever seen a mouse?
I don’t see this coming across the pond but who knows. Another interesting day on tap I’m sure.
BREXIT and the Russian war has made inflation much worse in the UK.