It went fine. Gilt yields are way down from panic highs. Another dream of the “pivot” mongers goes to heck.
By Wolf Richter for WOLF STREET.
The Bank of England today, as part of its quantitative tightening (QT), sold £750 million in UK government bonds (gilts) at auction. These bonds were part of the holdings the BOE had acquired during the QE program since 2009. The bonds it sold today had a remaining maturity ranging from about three years to seven years.
And so the BOE became the first major central bank to sell bonds outright as part of its QT.
Back on dual-track QT to speed up QT.
The bond sales come on top of the classic QT of letting maturing bonds roll off the balance sheet without replacement, which is what the Fed and the Bank of Canada are now doing.
The BOE already started QT in March this year. Three gilt issues matured and came off the balance sheet in 2022 without replacement: in March (£27.9 billion), in July (£3.2 billion), and in early September (£5.9 billion), for a combined £37.1 billion.
Over the next 12 months, another £35 billion in gilts will mature and come off the balance sheet. The outright sales of gilts, including the sale today, are on top of the maturities.
So now the BOE is back on dual track with its QT: Through outright sales of bonds and through letting maturing bonds run off the balance sheet.
These gilt maturities are few and far between – about two to five maturities per year – as the BOE holds gilts with very long maturities. Its longest dated gilt issue won’t mature until 2071. Over the next 10 years, £430 billion in gilts will mature, just a little less than half its current gilt holdings of £837.9 billion.
To speed up QT, the BOE has started its program of selling bonds outright at regular auctions. On October 20, the BOE laid out the revised schedule for the gilt sales in Q4, 2022. Over the next five weeks, from November 1 – today’s sale – through December 8, the BOE will hold eight auctions, selling short and medium maturity gilts, £750 million at each auction, for a total of £6 billion in five weeks. One down, seven more to go.
The BOE said it will announce the Q1 2023 auction schedule on December 16. Dual track QT back on track.
There had been a hiccup: pension-fund death-spiral interlude.
Today’s bond sale should have taken place in early October. That was the plan. The BOE’s Monetary Policy Committee had voted at its meeting on September 22 to start selling gilts outright in early October.
But on September 28, the whole plan was put on ice when highly leveraged UK pensions with £1.5 trillion in liability-driven investment (LDI) funds threatened to implode as the LDI strategy wasn’t designed for the sharp rise in long-dated gilt yields. The pension funds received margin calls from the investment banks that had sold those LDI strategies to them, and they were dumping gilts and other assets to meet those margin calls, which caused gilt prices to plunge further, and yields to spike further, which further threatened the pension funds, thereby creating a death spiral for gilts that began to spread into other assets.
The BOE stepped in on September 28, announcing that it would buy large amounts of long-dated gilts over a two-week period to calm the gilt market, and that it would put its planned bond sales on hold till November.
This was instantly hyped as another “pivot” by the Wall Street pivot mongers that had been predicting pivots by central banks left and right since May in order to manipulate markets higher. Famous hedge fund managers and bond fund managers with a big presence in the social media spread the word and showed up on TV mongering this pivot story, and it was eagerly lapped up by the crowd and spread from there.
Meanwhile, the BOE bent over backwards to explain that this wasn’t a pivot back to QE, but a short effort to calm a panic and give the pension funds time to deleverage their LDI-linked derivative positions.
Its primary goal is to contain inflation that is raging at 10%, and it needs rate hikes and QT, but it also needs markets to not spiral into a panic over the pension funds.
The BOE ended up buying just £19 billion of gilts, far less than the £90 billion of gilts it said it might buy. And as announced, the operation ceased on October 14.
So now dual track QT is back, and more rate hikes are in store. It has already hiked its policy rate seven times, including by 50 basis points at its September meeting, to 2.25%.
Markets have calmed. The government that had spooked the bond markets is gone. A new government has settled in. Everyone is going to have to pay more in taxes, it said, which further calmed the bond market. The bond vigilantes had risen from the dead and won their first battle in many years. The bond market calmed down. The 10-year gilt yield has dropped by about 110 basis points from peak panic to 3.46%. And the BOE can proceed with rate hikes and QT.
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