The Bank of England announced it would intervene today
The Bank of England (BoE) decision to intervene in the long-dated UK government bond market has stabilised the market and been broadly welcomed by investors.
This morning, the central bank said it would carry out temporary purchases of long-dated UK government bonds from today in order to "restore orderly market conditions" - adding the purchases would be carried out on "whatever scale is necessary to effect this outcome".
The BoE later said it would target conventional gilts with a residual maturity of more than 20 years in the secondary market, initially at a rate of up to £5bn per auction - noting the first auction would be conducted today (28 September) between 3pm - 3.30pm.
It said subsequent auctions would be conducted on each weekday from 28 September 2022 to 14 October 2022, between 2.15pm and 2.45pm.
Since the announcement, 25-year yields have fallen back from 5.023% at the end of yesterday to 4.068% at 3:30pm this afternoon. 30-year paper fell back from 4.991% to 3.975% over the same period.
These are yield levels similar to those seen at the end of Friday last week - but ones still significantly above where they were at the beginning of this month, when 25 year paper was yielding 3.163% and 30 year bonds 3.077%.
Aegon Asset Management head of rates Sandra Holdsworth said the BoE had stepped in to stop the gilt market from entering a "vicious spiral".
She said: "Selling in the both the conventional and index-linked gilt market has been intense in recent days. This has led to a huge demand for cash to support derivative structures popular amongst pension funds. Cash has been raised by selling more gilts, the prices fall and the circle continues."
M&G Investments chief investment officer of public fixed income Jim Leaviss agreed: "Pension funds have found themselves short of liquid collateral to pay to counterparties with which they have taken out 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 liability-driven investment (LDI) 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 - pension funds 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."
He said that, if the bank had not intervened, there would have been "mass insolvencies of pension funds by this afternoon".
Stabilising the market
Columbia Threadneedle Investments UK head of solutions and client portfolio manager Simon Bentley said the Bank of England's announcement that it would start buying long-dated gilts had been "well received" and should serve to stabilise the market, as evidenced by the immediate fall in real and nominal yields.
He said the commitments to scale purchases to the level needed to support markets and the reference to the urgency of the action were also helpful.
He added: "While time limited (to 14 October), this should be sufficient to allow defined benefit (DB) pension schemes the time to rebalance asset allocations and top up collateral pools in an orderly manner to maintain liability hedges. We will need to follow the market reaction in terms of liquidity, dealing costs and outright market levels to fully judge whether this action is sufficient, but it is a very welcome intervention for the time being."
Lane Clark & Peacock partner Dan Mikulskis agreed - noting that such a significant move in gilt yields in a very short space of time had been placing "a huge amount of operational strain" on the system that was designed to move money around in the event of yield rises.
He said the key timing pressures on schemes seem to have been eased as a result of the BoE announcement.
Mikulskis explained: "That gives schemes time to take stock of their current position, figure out what hedges they have, hedges they might have lost, what their current funding position is on different basis, and what their asset allocation is across different asset classes.
"Then they can work out what decisions they want to make to rebalance the asset classes back to their strategy, the transactions they need to make to do that, and the collateral that needs to be moved around to get everything working again. All this cannot be done overnight - it takes time."
Choppy markets
XPS Pensions Group chief investment officer Simeon Willis said the choppy market for gilts seen over the last few days represented "the most consequential event for pension schemes' investment strategies since the onset of the coronavirus pandemic".
He said that, while the Bank of England's intervention this morning would calm markets, the immediate effect had been a "whiplash effect" with yields falling sharply in morning trading.
He said: "While most schemes with hedging in place will have either emerged relatively unscathed from this morning's movements, some may have been caught out by missed collateral calls resulting in trimmed hedge positions in the last couple of days.
"The bank's intervention should hopefully lead to reduced volatility going forwards but schemes should still be proactive in looking at ways to shore up their liquidity position. Many schemes are in a position to reduce risk in light of recent funding improvements. In particular, well-hedged schemes should be focused on maintaining their hedges, while less well hedged schemes should be looking for ways to increase it whilst the favourable pricing lasts."
Good news for schemes
Barnett Waddingham partner Ian Mills said the intervention had effectively restarted the BoE's quantitative easing programme, despite the bank having announced on Thursday that it would start selling back the extensive holdings of gilts it has bought since the financial crisis.
Mills said the BoE's move today had, however, caused an immediate sharp drop in gilt yields, although noted they were still "significantly higher" than the levels in the middle of last week.
Despite all of this, he said the moves had been mostly positive for schemes.
Mills said: "For DB pension schemes this has mostly been good news - these schemes value their liabilities by reference to gilt yields and, for most, rising yields means an improving funding position. Importantly, most DB pension schemes' funding positions will now be stronger than they were a week ago."
However he said that many schemes had been hedging their risk of falling yields increasing their liabilities.
He said: "While this strategy has been very successful over recent years as UK yields have hit low after low, the operational risks of the strategy have, for some, crystallised in recent days. As yields rise the hedges need to be collateralised with cash, and some schemes have started to run low of cash and other liquid assets.
"The vast majority of schemes have been able to rebalance their asset portfolios quickly enough to raise the cash needed, but some schemes haven't. These schemes have been forced to unwind their hedges, and in some cases at the worst possible moment."
Mills added: "After the Bank of England's announcement this morning yields fell back sharply - schemes that were forced to unwind hedges this week may well have effectively locked-in losses to their funding positions."
"It's worth reiterating that the vast majority of DB schemes have successfully navigated this period of heightened volatility and have generally come out the other side in a better funded position."
