UK markets whipsaw as confusion reigns over nation’s policies

UK bonds tumbled while the pound rose as investors digested a deeply uncertain policy outlook from both the Bank of England and Liz Truss’s government.
The yield on 30-year gilts — favoured by the pension funds at the heart of recent market stress — rose as much as 22 basis points to 5.02% after a BOE spokesperson confirmed it plans to end its bond purchases on Friday. That’s the highest level since the central bank started intervening in the market last month.

Sterling rallied more than 1% to $1.1099 after a report from Politico that Truss may make further fiscal U-turns. The gyrations speak to deeply confusing policy signals for holders of UK assets.

“Anything is possible in the helter-skelter world of UK policymaking,” said Kit Juckes, chief currency strategist at Societe Generale.

The latest moves add to the volatile trading seen in UK markets since Chancellor of the Exchequer Kwasi Kwarteng announced a vast package of unfunded tax cuts last month, which saw the pound briefly hit an all-time low. Collateral calls from leveraged liability-driven investor strategies fueled disorderly trading in government bonds, particularly longer-dated and inflation-linked gilts.

In response, the BOE has made increasingly large interventions to protect financial stability. This week it expanded the amount of gilts it could buy in a given operation, launched the Temporary Expanded Collateral Repo Facility designed to help banks ease liquidity pressures on LDI clients, and expanded purchases to inflation-linked debt after a record selloff.

Friday deadline

BOE Governor Andrew Bailey warned fund managers late Tuesday they have until the end of this week to wind up positions they can’t maintain before the central bank halts its bond-buying. That rattled both the pound and global markets, with US stocks turning lower in late trading as US Treasury yields rose.

It came after the pension fund industry called for the central bank’s bond-buying program to be extended. Confusion was fueled by a Financial Times report that said Bailey had told lenders privately it could be continued, sparking a partial reversal in sterling.

The BOE on Thursday reiterated the Friday deadline for bond-buying. “The Governor confirmed this position yesterday, and it has been made absolutely clear in contact with the banks at senior levels,” a spokesperson said.

“In volatile markets, leverage is the enemy and the liquidity issues facing some pension funds have been building for years. What matters in the near-term is the extent of reduction in leverage by LDI funds and the premia the market assigns to the fiscal credibility of the government.”

Read more from Tanvir Sandhu, chief global derivatives strategist at Bloomberg Intelligence

Still, some analysts believe the BOE will continue its support if market conditions don’t improve.

“Bailey’s words did sound harsh but from the BOE’s perspective they need to sound stern,” said Pooja Kumra, rates strategist at Toronto-Dominion Bank. “The BOE has been very receptive to markets. If chaos continues we doubt that they will run away.”

The pound got a boost from a Politico report of a potential deferral of government tax cuts and possibly a further windfall tax. The UK said separately on Tuesday it would cap the revenue of renewable and nuclear power producers from next year, with details of how ministers will redistribute the revenue grab sparse.

“A lot of potential positive good news sentiment if Truss does a u-turn on corporate tax cuts, stamp duty,” said Jordan Rochester, a currency strategist at Nomura. “Macro factors still pointing to a trend lower,” he added.

Whatever the case, it’s clear that trading UK assets has become increasingly difficult, with JPMorgan Chase and Co. warning of a “permanent scar” to the nation’s borrowing costs. Columbia Threadneedle said it has halted withdrawals from a UK property fund because it’s unable to meet a flood of redemption demands.

“A longer-term solution is likely to be required in order to stabilise market conditions,” said Daniela Russell, head of UK rates strategy at HSBC Holdings Plc, of the BOE’s plans. “Pension funds are taking steps to address their liquidity issues but they are currently chasing a moving target as yields have continued to rise.”

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