Hurricane Liz

With mayhem in the financial markets, what better way to find out what’s really going on than hearing from retired City trader, Anthony Peters, in his new weekly column. Anthony, who describes himself as an “old bond dog”,  worked for more than three decades in most areas of the international bond markets and for some of the City’s best known firms. His first hand experience of booms and busts, heydays and crises should be of invaluable help guiding us through today’s volatile markets. 

While Hurricane Ian is battering the living daylights out of Florida, London is still suffering the full force of Hurricane Liz. And then up pops the Bank of England. The Old Lady has taken a lot of stick in the past year and in many ways not entirely without reason. Top of the list has been the Bank’s tardiness in responding to incipit inflationary pressures, only for it to find itself way behind the curve. Given that the UK always has leant more towards the United States than towards Europe – Brexit was genetically locked into the DNA of this country’s accession agreement to the EEC – there had in many parts been perplexity that British interest rate policy was lagging so far behind that being pursued by the Fed on the other side of the pond.

For reasons known only to God, who has not felt the need to share them with me, the UK has failed to develop a long-dated fixed rate mortgage market. Thus, UK borrowers, although they have had some pretty juicy offers of low-cost rates fixed for two, three or five years, were not able to lock in the ultra-low long-term rates which have prevailed over the past few years. With the inexorable rise in property prices outstripping wages by multiples, buyers have stretched themselves to the limit in order to either get onto the property ladder or to move into a larger property in line with a growing family. Against this backdrop, the tenets of Britain’s fabled house-owning democracy, the Bank had to tread carefully when tightening the monetary policy screws. The hue and cry in the media when it first moved by a humble 10 bps would have made one think, had one just returned from a trip to outer space, that the world was coming to an end.

It was in 1998 that the Rt Hon Gordon Brown, then Chancellor of the Exchequer under Tony Blair – or alongside him if you believe the myth – made the Bank independent and established the MPC as a rate setting body. Until then it had been the Chancellor himself – and until today it remains the last great office of state never to have been held by a woman – who determined what Bank Rate should be. In public consciousness, however, monetary policy is still somehow thought to be a driven by government as a result of which the Bank permanently finds itself between a rock and a hard place. The cause was of course not helped by the unlamented and preening Mark Carney who loved nothing more than to rub shoulders with the politicians of the day. If his grasp of monetary policy had been half as good as his PR, we might today be in a different place. But it wasn’t so we’re not.

Governor Andrew Bailey has taken a lot of stick – I too am guilty as charged – although, in the midst of the current crisis in confidence which has been brought on by announcement of the most probably ill-conceived and dismally inappropriately timed Truss/Kwarteng fiscal experiment, he has displayed extraordinary calmness. Many things came out of the GFC, one of which fell into the category of what was then termed as “unconventional policy measures” and was quantitative easing. Prior to that, the central banks could fiddle around with interest rates and to some extent intervene in the front end of the markets. But the ability to strike at all ends of the yield curve was then something new and what in 2008 was unconventional is now an established tool. If anybody ever cares to ask what the difference is between the current crisis which is rattling the country and the one of 1992, it is that the arsenal of measures available to the monetary policy authorities to act in markets has increased dramatically.

That said, the actions of yesterday had nothing to do with defending sterling which the Bank had already indicated it might do if necessary. It was, so we were told, to do with bailing out pension funds which had got themselves into trouble by playing around in the market and getting caught by margin calls on derivative contracts for which they lacked the liquidity to meet. Rumour has it that there were ones out there which were on the verge of insolvency following the astronomical rise in long rates. I have spent some time trying to get my head around what is supposed to have happened and why and have so far done nothing other than to draw blanks.

If the funds had been playing swaps and had locked themselves into paying fixed when long dated rates were next to nothing and receiving floating, they would be in clover. That they would have taken fixed and paid floating is inconceivable. The story began to emerge that they had lent their low yielding long dated gilts under repo agreements but that as the gilts market was getting filleted and the value of the collateral was declining, they were being called upon to offer supplementary collateral. How a pension fund with a disproportionate pile of assets relative to its current liabilities should not be in a position to post further collateral escaped me yesterday and even after a night of trying to work that one out, I am still perplexed.

To be sure, when committed pension fund liabilities far exceeded income streams which has in the past few years very much been the case, one can understand that the management teams would have been out there seeking any opportunity to enhance the current income but that still does not explain how they might have got themselves into existence threatening trouble. My guess is that there is something else which was occurring which we are not being told and which at this point in time I cannot identify.

One way or the other, the Bank of England yesterday pivoted from QT back to QE while in doing so also setting the stage for other monetary authorities to change direction and to once again take hold of the whole yield curve, were they to deem it to be necessary or desirable. Plenty of questions and so far, a dearth of answers.

The author is a retired City trader specialising in fixed income who now works as a freelance strategy consultant. 

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