December 1, 2023
A year after mini-budget ‘doom loop’, UK gilts are looking much less stressed

The Bank of England had to intervene in the gilt market – a year ago yesterday – acting as a circuit-breaker (Jordan Pettit/PA) (PA Wire)

Kwasi Kwarteng hoped his “growth plan” announced when he was Chancellor last September would be remembered as a bold and imaginative program to boost Britain’s economic potential.

Unfortunately, the now infamous “mini-budget” of unfunded tax cuts, without any independent oversight or medium-term economic forecasting, is known to have given rise to the “LDI (liability-driven investment) crisis”, which led to the 328- broke the year-long crisis. The old UK government bond or gilt market.

As soon as Kwarteng sat down following his statement in Parliament, prices for those gilts fell, breaking the record for the daily increase in yields.

Higher returns are generally good news for pension plans from a funding perspective. However, the unprecedented speed and scale of the selloff was devastating for many defined benefit plans with “leveraged LDI.”

Such schemes had to post “collateral” to meet counterparty margin calls when yields rose. With markets facing extreme levels of stress following the “mini-budget”, plans turned to the gilt market as the sole source of liquidity to sell assets to raise cash as collateral. Can be collected. Such sales meant that yields rose further, creating the need to post even more collateral, which required additional gilt sales.

As this “doom loop” persisted, the Bank of England had to intervene in the gilt market – a year ago yesterday – by acting as a circuit-breaker. It offered to buy £65 billion of gilts, allowing yields to return to “pre-mini-budget” levels.

A year after the crisis, “LDIs” have largely disappeared from market headlines and the Bank of England’s emergency asset purchase program has closed down entirely. This is notable, because the combination of high yields and record gilt sales meant that many commentators thought 2023 would be a very active year for this investor group.

However, rather than a major shift to reduce risk by locking in the higher yields on offer this year, LDI plans are more focused on getting their houses in order.

The plans have focused on improving their internal processes, reducing leverage and increasing the speed of access to liquidity. Additionally, until the Financial Conduct Authority announces its series of recommendations in April to increase the flexibility of LDI schemes, through the size of liquidity buffers they will have to put in place to protect them from rate rises, what will be the new industry standard , it had additional uncertainty.

All these measures have worked well, although with gilt yields approaching the highs seen last September, there have been few signs of stress or market dislocation.

The low prevalence of LDI in the gilt market has prompted further discussion from the Treasury’s Debt Management Office (DMO) about the “marginal buyer” of gilts in the coming years. The combination of government borrowing and Bank of England gilt sales (quantitative tightening) is equivalent to a supply of approximately £270 billion of nominal gilts and inflation-linked gilts during this financial year.

With signs of decline in demand from pension funds, DMOs wisely shifted gilt sales to shorter maturities of less than 15 years and away from longer maturities and linkers, which are typical targets for pension funds. These maturities are better suited to foreign investors, who have been tempted by the higher yields offered by gilts to reallocate their holdings to the UK, away from lower yielding domestic debt.

But, with next year’s Budget likely to require even higher volumes of gilt sales, DMOs will need to find additional sources of demand. We expect LDI schemes to become more active, making pension fund trustees more comfortable hedging their liabilities in this high yield environment.

However, perhaps the Treasury will need to be even more inventive, even actively tapping the retail sector for funding? The Italian Treasury, which is not inexperienced in financing large government borrowing, sold about 10% of its debt requirement to retail investors. Perhaps DMO will have to explore this option also?


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