A day after announcing a raft of measures aimed at calming tensions in the gilt market (greeted too sanguinely by yours truly) the Bank of England has been forced to step into the linker market as well.
Here is the statement Threadneedle Street just pushed out on including linkers in its daily offer to buy gilts (caped at £10bn a day for the next week). Our emphasis below:
The purpose of these operations is to enable LDI funds to address risks to their resilience from volatility in the long-dated gilt market. LDI funds have made substantial progress in doing so over the past week. However, the beginning of this week has seen a further significant repricing of UK government debt, particularly index-linked gilts. Dysfunction in this market, and the prospect of self-reinforcing ‘fire sale’ dynamics pose a material risk to UK financial stability.
Therefore the Bank is announcing today that it will widen the scope of its daily gilt purchase operations also to include purchases of index-linked gilts. This enhancement to our operations will be in effect from 11 October 2022 until 14 October 2022 alongside the Bank’s existing daily conventional gilt purchase auctions.
These additional operations will act as a further backstop to restore orderly market conditions by temporarily absorbing selling of index-linked gilts in excess of market intermediation capacity. As with the conventional gilt purchase operations, these additional index-linked gilt purchases will be time-limited and fully indemnified by HM Treasury. The Bank has also consulted with the Debt Management Office.
As announced on 10 October, the Bank stands ready to purchase up to £10bn of gilts each day, of which up to £5bn will be allocated to long-dated conventional gilts and up to £5bn to index-linked gilts. The pricing of this additional operation will reflect its nature as a backstop and that this is not a monetary policy instrument. The total size of these auctions will be kept under review. All purchases will be unwound in a smooth and orderly fashion once risks to market functioning are judged to have subsided.
It’s easy to see why the BoE felt it had to act again, just a day after announcing measures that it hoped would quell the turbulence. Here’s what the price of the 2073 inflation-linked gilt has done over the past month.
If you want to know what that looks like on a longer time horizon (the 2073 linker is the longest one out there, but was only issued last year), here is the price of the 2063 UK “linky-dink” issued in 2013.
Brutal. Linkers are far less liquid than the conventional gilt market, which means unusually large movements (for the rates market) can happen. But it’s a hugely popular investment for the by-now infamous LDI community, and this indicates real stress.
In fact, it’s kinda weird that the Bank didn’t include it in its initial operations alongside plain vanilla UK government bonds, and certainly when it expanded its repo window to include high-grade corporate bonds yesterday.
We suspect the Bank isn’t averse to seeing gilts selling off per se — it is natural that they do so in the current environment — but when the sell-off becomes chaotic and dangerous to the UK’s financial system. The accompanying “Market Notice” with the details of the operation repeats multiple times that this is all about “financial stability”.
Perhaps all monetary policy is financial stability policy these days.
