UK Buying bonds, Resumes QE, and US Market is up 550-600 points .. what's next?

[cyber888]

So, the US Market today got blessed by the UK action of buying bonds, resuming QE, causing the 10-Year US Treasury yield to dive by -6.53% back to 3.70% and pushing stocks up.

What do you guys see next? Some commenters are seeing capitulation

 

[aja8888]

So, the US Market today got blessed by the UK action of buying bonds, resuming QE, causing the 10-Year Treasury yield to dive by -6.53% back to 3.70%

What do you guys see next? Some commenters are seeing capitulation

U.K. said they will end this as soon as the bond market quiets down. Here's Wolf's article posted today (even before they started QT):

https://wolfstreet.com/2022/09/28/u...plunge-bank-of-england-buys-long-dated-bonds/

Over the past few days, the pound plunged, including with a flash-crash on Monday that briefly took it to record lows against the US dollar. Prices of long-dated bonds went into a death spiral, with the 10-year yield spiking by 130 basis points in four trading days to 4.63% early today, and by 275 basis points in seven weeks ago (up from 1.88% in early August).

The bond market reaction represents a colossal and sudden degree of “tightening” of the financial conditions, before the Bank of England’s QT had even started. QT is designed to bring up long-term yields, but they already exploded due to chaos.

 

[cyber888]

U.K. said they will end this as soon as the bond market quiets down. Here's Wolf's article posted today (even before they started QT):

https://wolfstreet.com/2022/09/28/u...plunge-bank-of-england-buys-long-dated-bonds/

I guess there's a lot of uncertainty with the new UK governments tax cuts, that will affect the bond markets, QE or QT. How soon is a question mark too.

 

[aja8888]

I guess there's a lot of uncertainty with the new UK governments tax cuts, that will affect the bond markets, QE or QT. How soon is a question mark too.

Yes, tax cuts for the wealthy were not received very well. And increasing taxes on energy companies when you really need them was not that well received either. The bonds (Gilts) crashed and U.K. pension funds were called upon to supply collateral (cash) to cover their leveraged positions. It's a house of cards in the UK and QT has not even started yet. This is a disaster in the making.

 

[cyber888]

Yes, tax cuts for the wealthy were not received very well. And increasing taxes on energy companies when you really need them was not that well received either. The bonds (Gilts) crashed and U.K. pension funds were called upon to supply collateral (cash) to cover their leveraged positions. It's a house of cards in the UK and QT has not even started yet. This is a disaster in the making.

Right. I'm not sure if this is the right policy direction, and how long this new Prime Minister will last.

 

[aja8888]

Right. I'm not sure if this is the right policy direction, and how long this new Prime Minister will last.

She certainly got a wake up call this week, but she can always blame the Bank of England if things really go South! (all the baseload problems didn't happen on her watch)

 

[audreyh1]

What?!?

 

[luckydude]

So, the US Market today got blessed by the UK action of buying bonds, resuming QE, causing the 10-Year US Treasury yield to dive by -6.53% back to 3.70% and pushing stocks up.

What do you guys see next? Some commenters are seeing capitulation

Maybe Liz Truss attended the Jerome Powell School of Economics and thinks the inflation hitting UK is transitory.

 

[Alan]

In the UK all budgets are reviewed and reported on by the independent Office of Budget Responsibility, OBR, and by not declaring this recent budget a “budget” the OBR did not scrutinize it and issue a report. Huge cuts in revenue from the largest tax cuts in a generation and no balancing income or cuts in spending. The UK government is supposed to produce at least one budget a year which doesn’t have to balance but has to be analyzed by the OBR.

The UK economy is in free fall and it is all self inflicted.

 

[jim584672]

I'm puzzling on why a change in bond prices would endanger anything. Are they using high leverage or something?

 

[Alan]

I'm puzzling on why a change in bond prices would endanger anything. Are they using high leverage or something?

The UK government is highly leveraged. (Debt load is now 2.1 trillion GBP which is about the same as its GDP)

It's all gobbledy-gook to me but as treasury bond (gilts) prices plunge and their interest rates soar in response the cost of UK borrowing also soars.

https://www.gov.uk/government/news/hmt-response-to-bank-of-england-financial-stability-intervention

The Bank of England, in line with its financial stability objective, carefully monitors financial markets and any potential risk to the flow of credit to the real economy, and subsequent effects on UK households and businesses.

Global financial markets have seen significant volatility in recent days.

The Bank has identified a risk from recent dysfunction in gilt markets, so the Bank will temporarily carry out purchases of long-dated UK government bonds from today (28 September) in order to restore orderly market conditions. These purchases will be strictly time limited, and completed in the next two weeks. To enable the Bank to conduct this financial stability intervention, this operation has been fully indemnified by HM Treasury.

 

[aja8888]

I'm puzzling on why a change in bond prices would endanger anything. Are they using high leverage or something?

Read the Wolf Street article I linked above in a post. It discusses the leverage situation in detail.

 

[GravitySucks]

Hard to ascribe yesterday's bump in US markets to this news.

 

[MichaelB]

I'm puzzling on why a change in bond prices would endanger anything. Are they using high leverage or something?

According to the FT, the problem was UK pension funds using fixed income derivatives to fund their long term liabilities. An increase in long term interest rates had the effect of a margin call on them, and to meet it they needed to sell long dated gov’t bonds. This made interest rates rise even more, which created a vicious cycle. The only way to stop it was for the BoE to announce it was buying those long term bonds, stopping the price decline - for now.

 

[11522914]

I guess reality set in today. Nice short squeeze yesterday.

Crazy.

 

[jldavid47]

According to the FT, the problem was UK pension funds using fixed income derivatives to fund their long term liabilities.

In other words they were short interest rates and when rates soared they got their asses handed to them. Being on the wrong side of a market when you are short a derivative on that market is a bitch. I know. I've been there (unfortunately).

 

[jldavid47]

I guess reality set in today. Nice short squeeze yesterday.

Crazy.

Two words: Bear Market.
Three more words: Imploding Everything Bubble.

 

[audreyh1]

The UK economy is in free fall and it is all self inflicted.

Bummer!!

I assume the bulk of your investments are still in the US?

 

[audreyh1]

I guess reality set in today. Nice short squeeze yesterday.

Crazy.

Yeah, occasionally there are these one day wonder surprises even in a bear market.

 

[Alan]

Yeah, occasionally there are these one day wonder surprises even in a bear market.

They have to be in the USA because as a USC any pooled investments such as mutual funds are treated as PFICs and taxed punitively. Vanguard.co.uk does not even accept USCs as customers.

 

[jldavid47]

Yeah, occasionally there are these one day wonder surprises even in a bear market.

If you drop a dead cat from a high enough ledge it will bounce.

 

[copyright1997reloaded]

In other words they were short interest rates and when rates soared they got their asses handed to them. Being on the wrong side of a market when you are short a derivative on that market is a bitch. I know. I've been there (unfortunately).

I've been wondering about some of the specifics on this. One thing I've heard is that the UK pension funds for DB (defined benefit) plans had an issue as rates fell. Typically, pension funds will use long term bonds for a good portion of their expected payouts. As rates fell, it became impossible to keep the same bon return -> income flow, so the pension funds would have had to:
a) Require higher contributions for a given expected benefit, or
b) Reduce the benefits.
Neither of these would have been acceptable, so they needed another approach.

One way would be to buy "riskier" assets than known maturity bonds. For example stocks.

Another approach is to leverage up on their (now lower coupon) long bonds by borrowing short and using that to buy EVEN MORE long bonds. With short term rates near/at zero, this was an effective strategy.

All is fine and dandy with such an approach UNTIL short term rates rise, and especially bad if short term rates exceed long term rates (i.e. an inverted yield curve). Now they have a negative spread (oops) between the borrow short and buy long strategy.

LEVERAGE KILLS.

The BOE realized that the pension funds had a big big problem, so what to do? Print money, i.e. QE. So much for tamping down inflation and QT.

 

[11522914]

I've been wondering about some of the specifics on this. One thing I've heard is that the UK pension funds for DB (defined benefit) plans had an issue as rates fell. Typically, pension funds will use long term bonds for a good portion of their expected payouts. As rates fell, it became impossible to keep the same bon return -> income flow, so the pension funds would have had to:

a) Require higher contributions for a given expected benefit, or

b) Reduce the benefits.

Neither of these would have been acceptable, so they needed another approach.



One way would be to buy "riskier" assets than known maturity bonds. For example stocks.



Another approach is to leverage up on their (now lower coupon) long bonds by borrowing short and using that to buy EVEN MORE long bonds. With short term rates near/at zero, this was an effective strategy.



All is fine and dandy with such an approach UNTIL short term rates rise, and especially bad if short term rates exceed long term rates (i.e. an inverted yield curve). Now they have a negative spread (oops) between the borrow short and buy long strategy.



LEVERAGE KILLS.



The BOE realized that the pension funds had a big big problem, so what to do? Print money, i.e. QE. So much for tamping down inflation and QT.

Thanks for the detailed explanation. I wonder if US pension funds have done the same thing.

 

[copyright1997reloaded]

Thanks for the detailed explanation. I wonder if US pension funds have done the same thing.

That is the bazillion dollar question. Or how many have done other non-traditional approaches trying to juice returns?

 

[11522914]

That is the bazillion dollar question. Or how many have done other non-traditional approaches trying to juice returns?

I'm sure we'll find out soon enough.