“Why were they forced into this at a time where they’re seemingly so keen on tightening monetary policy?” Nomura’s Charlie McElligott asked, on Wednesday, following the Bank of England’s announcement of unlimited long-end bond purchases to stem an existential crisis in gilts.
He had an answer. The meltdown was on the brink of becoming a “death spiral,” as liability-driven investors and defined-benefit pension plans risked forced liquidations.
Gilts, stocks and corporate credit would be “rationally” sold “to meet ratcheted-up margin calls on derivatives and leveraged repo positions, due to the quantum of the collapse in gilts and sterling,” McElligott wrote.
The figure (above) shows the “quantum” of the “collapse,” although I doubt most readers need the visual reminder.
“Today’s action from the BoE is pure and simple a pension fund bailout,” Charlie wrote. He was adamant. Pension funds were bailed out of a margin-call liquidation spiral,” he said. “Period, end of story, full stop.”
The BoE is attempting a delicate balancing act, to put it nicely. Conjuring a rapidly depreciating currency to buy interest-bearing versions of that same currency from yourself when markets have lost confidence is potentially perilous. McElligott called it “wild.”
“You’re gonna fund these purchases with new reserves, with a currency already being melted due to the insanity of unfunded fiscal stimulus into an inflation overshoot?” he wondered, incredulous. “The currency should be getting destroyed.”
It’s hard to argue with that when presented as such, although I suppose I’d (very gently) note that not short circuiting this spiral could have far-reaching consequences in the event the UK were to lose market access entirely. After the last several days, that seemed like a possibility. It’s difficult to overstate the implications of a reserve currency issuer losing market access virtually overnight.
That said, there’s most assuredly something farcical about the whole thing. The BoE is perpetuating a circular funding scheme at a time when markets have clearly telegraphed displeasure with what’s being funded — or, more aptly, what’s not being funded.
“Despite today’s BoE actions being idiosyncratic in light of the fiscal policy decisions of the new government, the fact is, QT has already broken markets, and as of today, the Bank of England became the first central bank to ‘bend the knee’ back to markets,” McElligott said. The bank, he emphasized, is being forced to expand its balance sheet “at a time when they’re supposed to be trying to tighten monetary policy and lean into inflation.”
If the end game is a de facto “downgrade” of the UK to emerging market status, it’ll mark an unceremonious denouement to the long-running decline of British empire. And just a week after the Queen was laid to rest.
“Gilts, stocks and corporate credit would be ‘rationally’ sold ‘to meet ratcheted-up margin calls on derivatives and leveraged repo positions’….”
Fool me once, shame on you; fool me twice…
Why would pension funds face margin-call liquidation spiral? They are not leveraged, are they?
While the great Wall Street insurance companies, controlling in their reserves hundreds of billions of the accumulated savings held for “the widows and orphans,” are prohibited by law from investing in stocks, the law does not say that they cannot, to help out their stock-market masters, deposit billions of money in the banks and thus enable such banks during a great market manipulating campaign to loan to inside operators billions of dollars of additional credit to aid them in running the gamble against the public, the living fathers, husbands and brothers of such future “widows and orphans.” Whatever the amount, they certainly deposit many billions in the big banks.
Trading in futures markets is inherently leveraged, even in situations where you’re only <= 100% invested. You have a large number of counterparties, and have to post collateral with all of them. For the market to function at all, that collateral needs to be relatively small in proportion to potential position sizes, which can result in big margin calls in the event of sudden large market moves.
Another tool for central banks’ balance sheet tool box — QE, QT, and now, QE + QT. My grandfather used to say that sometimes having too many tools gets in the way of the job.