Bank of England expands bond market bailout to restore UK financial stability

“The dysfunction of this market, and the potential for reinforcing ‘fiery selling’ dynamics poses a material risk to the UK’s financial stability,” the Bank of England said.

The yield on UK inflation-linked 30-year bonds has risen above 1.5% this week, up from 0.851% on October 7, according to the

Tradeweb.

Just weeks ago, the yield on government bonds, as British government bonds is known, was negative. As yields rise as prices fall, the impact has been punishing bond investors for losses.

On Tuesday, after the Bank of England expanded its buying, the yield on inflation-linked government bonds remained mostly flat but at new highs. The central bank said it had bought nearly 2 billion pounds, equivalent to about 2.21 billion dollars, in inflation-linked financial securities, out of a daily capacity of 5 billion pounds.

However, the bank should run out of bond purchases on Friday. The Pensions and Lifetime Savings Association, a trade body representing the pension industry, urged the central bank on Tuesday to extend its purchases until the end of the month.

Almost daily expansion Bank of England rescue plan Highlight the challenges central banks face in eliminating the problems that fuel them Inflation increases once in a generation and interest rates. It also raised questions about whether the Bank of England was providing the right medicine to tackle the problem.

The unrest sparked new demands on Monday for pension funds to provide liquidity to support LDIs, or… Commitment-driven investmentsThese are derivative strategies designed to help match the money they owe to retirees over the long term.

LDIs were the root cause of bond selling that stimulated The original intervention of the Bank of England. Retirement plans in late September saw a flurry of margin calls after Prime Minister Liz Truss’s government announced their size, debt-financed tax deductions That fueled an unprecedented selloff in the bond market.

Bank of England launched Original Bond Purchase Program on September 28, but it only calmed down for a few days before selling resumed. Monday’s expansion of the program backfired, with revenue soaring again.

Simeon Willis, chief investment officer at XPS, a company that advises on pension plans, said Monday’s sale was “very reminiscent of what happened two weeks ago.”

LDI strategies use leveraged financial derivatives linked to interest rates to magnify returns. The huge moves in the UK bond markets last month led to that Huge insurance calls on pensions To support leveraged investments. Pension funds sold other assets, including government and corporate bonds, to meet those calls, adding pressure on yields to rise and creating a spiral effect on markets.

Pensions are usually the largest holders of inflation-linked government bonds, which helps protect plans from both inflation and interest rate changes. But those were not eligible for the BoE’s bond-buying program until Tuesday.

The UK helped pioneer bonds with inflation-linked payments, sometimes referred to as bonds, in the 1980s. Links was originally sold exclusively to pensions, but the UK has opened it up to other investors over the years.

Pensions remain a dominant force in the market because bonds provide long-term protection against both inflation and interest rate changes. Their outsized role has left the market vulnerable to shifts in demand for pension funds like those seen in recent weeks.

Adam Skerry, a fund manager at Abrdn with a focus on inflation-linked government bonds, said his company has struggled to trade those assets in recent days.

“We were trying to sell some bonds this morning, and it was virtually impossible to do that,” he said. “The LDI problem facing the market, and the fact that the market is moving to the degree that it was, especially yesterday, suggests that there is still a lot to do. [of selling] there.”

Pensions also seemed reluctant to sell their bonds to the Bank of England, reflecting a mismatch of what the central bank is offering and what the market needs.

“The way the bank has structured this intervention is that it can only buy assets if people make bids in them, but no one is making bids,” said Craig Inches, head of rates and cash at Royal London Asset Management. He said pension funds prefer to sell their riskier assets, including corporate bonds or property.

XPS’s Willis said many pensioners want to hold their government bonds because they help protect pensions from changes in interest rates, which affect the way their liabilities are valued.

“If they sell gold now, they are probably doing so because they will have to buy it again in the future at some point and it may be more expensive, which is not helpful,” he said.

The program suffers, too: Pension funds are traditionally slow-moving organizations that make decisions with multi-decadal horizons. Market turmoil has driven them into twisting velocity moves usually reserved for arrogant hedge fund traders.

To make decisions about selling assets, players in the industry describe a phone game played between trustees, investment advisors, fund managers, and banks. Pension funds distribute their assets among multiple managers, which in turn are held by separate custody banks. Inviting everyone to obtain the necessary approvals creates a long and complex process.

To give themselves more time, pension funds are pushing the Bank of England to extend its bond-buying program until at least the end of the month. This is when Britain’s Chancellor of the Exchequer, Kwasi Quarting, is expected to lay out the government’s borrowing plans for next year.

The Institute for Fiscal Studies, a nonpartisan think tank focused on the budget, warned on Tuesday that borrowing was likely to reach 200 billion pounds in the financial year ending in March, the third highest in the financial year since World War II and up by 100 billion pounds. pound. than planned in March of this year. Increased borrowing increases the supply of bonds and generally leads to higher bond yields.

Mr Kwarteng on Tuesday declared his confidence in Bank of England Governor Andrew Bailey when he faced questions from lawmakers for the first time in his new job.

“I speak to the governor very frequently and he is a completely independent person who is managing the global situation very effectively,” he said.

—Caitlin Ostrov contributed to this article.

write to Chelsey Dulaney at [email protected], Anna Hertenstein at [email protected] and Paul Hannon at [email protected]