Investors were braced for volatile trading in U.K. government bonds after the Bank of England stressed it would stop intervening to bolster the market as planned at the end of the week, but reports said it had told bankers privately it could provide further support if necessary.
After falling to a fresh two week low near $ 1.09 early on Wednesday, the pound GBPUSD, +0.48% was up 0.3% on the session to $ 1.1005. Ten-year gilt yields TMUBMUSD10Y, 3.920% had closed Tuesday at 4.439%, near to their highest since 2008.
U.K. gilts have been in turmoil since the government in late September announced a budget of large debt-funded tax cuts, spooking fixed-income investors. A spiral of bond selling ensued as pension funds, facing margin calls on their derivative positions, were forced to liquidate holdings. The Bank of England stepped in two weeks ago with a £65 billion ($ 71 billion) bond-buying program to calm the market.
BoE governor Andrew Bailey, speaking in the U.S. on Tuesday after the London markets had closed, took a tough line on the pension funds in an attempt to highlight the need for them to swiftly de-risk their derivative strategies.
“We have announced that we will be out by the end of this week. We think the rebalancing must be done,” Bailey said at an Institute of International Finance event in Washington. “And my message to the funds involved and all the firms involved managing those funds: You’ve got three days left now. You’ve got to get this done.”
Bailey’s comments sparked selling in U.S bonds, equities and the pound as investors feared further instability in the fixed income market. Traders have become increasingly concerned of late that severe stresses in the financial system may emerge as central banks switch from the era of zero or negative interest rates to sharply higher borrowing costs as they try to tackle inflation at multi-decade highs.
“[G]lobal financial conditions have tightened as central banks continue to raise interest rates. Our latest Global Financial Stability Report shows that financial stability risks have increased since our last report, with the balance of risks tilted to the downside,” said the International Monetary Fund in a report released on Tuesday.
Analysts were aghast at the BoE governor’s rigid line.
“Bailey’s tone is particularly perplexing given some funds have suggested they need more time to stabilise their portfolios, and the Bank of England’s warning yesterday of a fire-sale risk in markets. If you really believe, there’s a fire-sale risk why then turn around and put a 3-day time limit on pension funds to sort out their risk profile? ” said Michael Hewson, chief market analyst at CMC Markets.
“Markets don’t work like that and further volatility in the coming days could well raise the prospect of another U-turn and deal another blow to the central bank’s credibility, as well as the credibility of Bailey himself,” Hewson added in a note written before the Financial Times reported the BoE had been telling banks privately that support may continue past the Friday deadline.
“All the BoE efforts have gone up in smoke. What Bailey did was certainly one of the biggest communication mistakes that a central banker could make. And it really came at an unfortunate time,” said Ipek Ozkardeskaya, senior analyst at Swissquote Bank.
“The gilt yields remain at alarming high levels, the UK’s gilt market remains extremely slippery,” she added.