Prime Minister Kwasi Kwarten’s mini-budget has led to an ‘unprecedented’ crash in the UK bond market, according to the Bank of England, as pension funds that manage billions of dollars on behalf of retirees across the UK collapsed. It is said that it was on the verge.
The central bank last week laid out emergency interventions to calm financial market turmoil, putting ‘many’ of pension funds investing more than £1 trillion at risk of bankruptcy, putting them under severe strain. said to be exposed.
The bank said interest rates on long-term UK government bonds rose dramatically in the days immediately after the prime minister’s mini-budget triggered a ‘self-reinforcing’ spiral in bond markets, jeopardizing the stability of the UK’s financial system. rice field.
Without the World Bank intervening in its promise to buy up to £65bn of government bonds, funds managing money on behalf of pensioners across the country would be left with “negative net asset values” and unable to meet their cash needs. I don’t think so.
“As a result, these funds will likely have to start the liquidation process the next morning,” the bank said.
The central bank said there was a risk that the meltdown would spill over into the UK’s financial system, which could have caused an “excessive and sudden tightening of funding conditions for the real economy”.
Threadneedle Street stepped in last week after the pound fell to an all-time low against the dollar and interest rates on British government bonds climbed to their highest levels since the 2008 financial crisis.
In a letter to the Commons Finance Committee outlining the intervention, the bank’s vice governor for financial stability, John Cunliffe, suggested that the biggest market moves came after the prime minister’s mini-budget.
On Thursday, Sept. 22, the day banks raised interest rates, he said the currency was “broadly stable” and long-term interest rates, or yields, on government bonds had risen by about 20 basis points. It wasn’t until a day after Kwarten announced his £45bn outstanding tax cut that World Bank market intelligence identified pension fund managers’ initial concerns.
Cunliffe said the pound fell about 4% against the dollar and 2% against the euro while long-term bond yields were in a “very bad” situation with the number of buyers and sellers ready to trade on the day. It was up 30 basis points, he said.
Ministers attempted to argue that the market turmoil reflected global factors. We published a chart highlighting the steep rise in costs.
Citi sources warned last week that a “doom loop” had emerged for pension funds invested in debt-driven investments (LDIs). The fund invested in complex derivatives using long-term government bonds as collateral. The assets were pledged as collateral to back financial contracts.
Quick guide
A Glossary of Key Terms Explaining the UK Economic Turmoil
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Financial policy
Since 1997, the Bank of England’s work has had a statutory mandate to meet the inflation target set by the government (currently 2%).
fiscal policy
The Treasury Department is responsible for fiscal policy, including taxation, public spending, and the relationship between the two. “Fiscal easing” is when planned tax cuts do not match planned spending cuts.
budget deficit
Gap between government spending and tax revenue
government debt
Total annual budget deficits – and less frequent surpluses – over time.
government bond
In the UK these are known as gilts and are a way for states to borrow to finance their spending. The fact that governments guarantee repayment to investors means that they are traditionally considered low risk. Bonds come to maturity on different timescales such as 1, 5, 10 and 30 years.
bond yields and prices
Most bonds are issued at a fixed interest rate and the yield is the return on the capital invested. When the Bank of England cuts interest rates, fixed yields on gold coins become more attractive, pushing prices higher. However, when interest rates rise, gold coins become less attractive and prices fall. Therefore, when bond prices fall, bond yields rise and vice versa.
short-term and long-term interest rates
Short-term interest rates are set by the Bank of England’s MPC, which meets eight times a year. Long-term interest rates fluctuate with gold coin yields, but most important he is the 10-year gold coin yield. Long-term interest rates affect the cost of fixed-rate mortgages, overdrafts, and credit card borrowings.
Quantitative Easing and Quantitative Tightening
Buying bonds by the Bank of England is called quantitative easing (QE). This is because banks pay for the bonds they buy by creating electronic money. It hopes to find its way into the financial system and the wider economy. Quantitative Tightening (QT) has the opposite effect. Reduce the money supply through the sale of assets.
Pension funds and the bond market
Pension funds tend to be large holders of bonds because they provide a relatively risk-free way to guarantee payments to retirees over decades. Bond prices tend to move relatively slowly, but pension funds still take out insurance as a safeguard to limit their exposure. A sharp drop in bullion prices could invalidate these hedges.
margin call
A purchase on margin is when an investor or institution purchases an asset through a down payment and borrows money to cover the remaining costs. The advantage of margin trading is that it allows for bigger bets and higher returns in good times. However, investors must provide collateral to cover losses during recessions. In times of stress, additional collateral must be found, often very quickly Margin he is subject to calls.
doom loop
This is where the financial crisis begins as institutional investors are forced to sell large amounts of assets to meet margin demands. If a pension fund sells gold coins to a declining market, the result will be lower gold coin prices, higher coin yields, higher losses, and increased margin demands.
financial control
This is where the size of the budget deficit run by the Treasury has prevented the Bank of England from taking the actions it deems necessary to combat inflation. be done. Banks may keep interest rates lower than usual to reduce the government’s interest payments on borrowings. Or it could buy more gold coins to cover government borrowing.
Larry Elliott economic editor
Amid the post-mini-budget market turmoil, the value of UK government bonds fell sharply as investors began to lose confidence in the credibility of the Truss government to implement sustainable tax and spending policies. This meant yields moved inversely to bond prices, reflecting rising government borrowing costs.
As a result, pension funds invested in the LDI scheme faced rolling margin calls as the value of the bonds they pledged as collateral collapsed. The fund then began selling other long-term bond holdings to meet its cash needs, which put further selling pressure on the bond market in a self-reinforcing downward spiral.
Cunliffe said the bank had received information that the fund was preparing to sell at least £50bn of long-term government bonds in the short term.
In the period just before the World Bank intervened, UK 30-year government bond yields rose 35 basis points in two days. Data going back to the turn of the century showed the largest daily gain until last week was 29 basis points.
Measured over four days, the increase was more than double the largest move since 2000. The move came during a “dash for cash” at the start of his Covid-19 pandemic, when global financial markets plunged into one of the world’s financial markets. The worst meltdown since the Wall Street Crash of 1929.
On Thursday night, a spokesperson for the Treasury Department said the turmoil was a global problem, saying: “While we have seen turmoil in the UK, global financial markets have also experienced significant volatility in recent weeks. ‘ said.
They added: Our growth plan unlocks growth and makes the UK more competitive.
“The government is committed to tightening fiscal discipline and reducing debt as a percentage of GDP over the medium term.
