November 24, 2022
  • November 24, 2022

The BoE in troubled waters with a skilled ‘all it takes’: Mike Dolan

By on September 30, 2022 0

LONDON, Sept 30 (Reuters) – “Limited time” and “all it takes” don’t go together.

Even though a law of diminishing returns suggests that the legendary “whatever it takes” warning from policy makers to markets is fading somewhat, the phrase still derives its power from its simplicity and boundless commitment to overwhelming force. .

Used most effectively in the financial context by the then head of the European Central Bank, Mario Draghi, 10 years ago, it all but ended the sovereign debt crisis raging in the eurozone by signaling simply the ECB’s unlimited use of all available firepower for as long as it took to stabilize. The boat.

Without taboos, without size or time constraints.

The circumstances, context and exact wording may be different this week, but the Bank of England emulated some of that language on Wednesday in its dramatic decision to buy UK government bonds to prevent a so-called market implosion. gilts.

With the market malfunction threatening to cause a catastrophic loop of pension fund calls and forced sales due to soaring yields, vastly exaggerated by the UK government’s tax cut budget plan last Friday, the Bank clearly had to act – albeit ostensibly against the push for its monetary policy tightening.

“The purpose of these purchases will be to restore orderly market conditions,” the BoE statement said. “Purchases will be made on the scale necessary to achieve this outcome.”

Hard-hitting words, with some echoes of 2012.

Like the ECB 10 years ago – or again this year when it designed an anti-fragmentation tool to limit intra-euro borrowing spreads – the BoE justified Wednesday’s intervention by the need for a good functioning of the markets to adequately transmit its monetary policy.

Yet unlike the ECB a decade ago, the BoE’s underlying monetary policy is the opposite of what it needs to do to calm markets and risks undoing its interest rate hike campaign. interest in controlling inflation. Most notably, it is bucking its commitment to reduce its balance sheet by over £800bn by actively selling £80bn of gilts over the coming year as part of its quantitative tightening (QT) commitment. ).

So much so that the BoE was forced to qualify the seemingly forceful line “on whatever scale necessary” with what Deputy Governor Dave Ramsden stressed on Thursday would be a “strictly time-limited” operation.

The hope is that this gives pension funds just two weeks to sort out the long-term liquidity and collateral issues in the bond market – and allow the BoE to unwind these purchases “smoothly” once again. , to resume delayed QT selling next month and deliver what futures markets now assume will be a whopping 1.25 percentage point hike in its key rate on Nov. 3.

It is a hopeful expectation.

GOLDEN JOURNEY

If the problem was pretty much a quarter-end quirk in derivatives coverage, maybe it works.

But if the central issue is skyrocketing bond yields and swap spreads amid soaring inflation expectations, rising rates, unfunded tax cuts and a plummeting pound, then it could happen until the end of the year at the latest.

“While the Bank of England’s intervention on Wednesday averted a vicious cycle of forced selling that had begun, the underlying risks of high inflation, a weak pound and uncertainties over the UK’s fiscal plans government remain,” said Derek Steeden, portfolio manager at Invesco Solutions.

Steeden said collateral calls are expected when gilt yields rise and most pension plans have a pre-determined order of which assets to sell first.

But while schemes had tapped into those reserves in recent months as yields rose, he said the latest spike, which saw 30-year interest rate swaps inflate by more than 100bps, means they must now sell well beyond the gilt market, especially as pressure to “de-risk” funds increases, as the discount rates determining funding levels are much higher.

“It’s not over yet – many UK pension funds invest globally but have sterling exposures and use currency hedging programs to help neutralize the impact of currency movements,” he said. he pointed out. “These programs have not yet settled the losses resulting from the fall of the pound.”

So if the BoE can’t put out the fire completely over the next couple of weeks, the “time-bound” commitment could become hazier than two weeks – further complicating its monetary policy in a way that the economist in Chief Huw Pill swore it Thursday wouldn’t.

It could even lead to a confusing scenario that HSBC calls “operation twist,” where it ends up buying long-term gilts and selling short-term paper at the same time, and inverting the yield curve even further.

Either way, sterling’s vulnerability will continue to attract speculators who now see a myriad of policy inconsistencies.

Hedge funds are licking their lips.

John Floyd’s Floyd Capital Management believes that falling yields are making it difficult to finance the UK’s massive external deficit and that a weaker currency will have only been the balancing mechanism. Veteran trader and family office manager John Taylor was more candid: “It’s never too late to be short of sterling.”

Stanley Druckenmiller, who helped organize the 1992 billion-pound bet on the pound’s exit from the European exchange rate mechanism when he was at Soros Fund Management, doubts the BoE’s plan this week improves the overall situation.

“The situation in England is quite serious because 30% of mortgages are moving towards variable rates,” Druckenmiller said. “What you’re not doing is taking taxpayers’ money and buying 4% bonds. That creates long-term problems.”

Unfortunately, time is not on the side of the BoE.

The opinions expressed here are those of the author, columnist for Reuters.

(by Mike Dolan, Twitter: @reutersMikeD; additional reporting by Nell Mackenzie and Carolina Mandl)