EDITOR'S NOTE: Imagine hearing this warning from a central bank: You’ve got three days to wind up positions in the market that you can’t support. That warning, addressed to fund managers, came from the Bank of England. It meant: sell every position you can’t maintain with adequate levels of capital for the Bank of England will no longer support the market. This comment sent the pound and US equities tumbling. What’s the BoE expecting to accomplish in this intervention? And what kind of a mess does this put financial institutions in the UK in? And what might this mean for US markets? It’s a complicated situation, and here’s what the situation looks like now. If you want a speculative take on its global implications, we suggest you also check out Tyler Durden’s take on Zerohedge.
(Bloomberg) -- Bank of England Governor Andrew Bailey warned fund managers they have until the end of this week to wind up positions that they can’t maintain before the central bank halts its market support, triggering a selloff in the pound and US stocks.
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“My message to the funds involved and all the firms is you’ve got three days left now,” Bailey said at the Institute of International Finance annual meeting in Washington on Tuesday. “You’ve got to get this done.”
The comments rattled broad markets, with US stocks turning sharply lower in late trading as Treasury yields rose. The pound fell below 1.10 versus the dollar for the first time since Sept. 29 and weighed on stock indexes. It was last 1% lower at 1.09 at 4:10 p.m in New York.
The Bank earlier on Tuesday expanded the range of its bond-buying program to include inflation-linked debt for the first time to avert what it called a “fire sale” that threatens financial stability. While the central bank has always said its support will end Friday, a lobby group representing UK pension funds urged Bailey to extend the program at least until the end of the month, saying that investors hadn’t been given enough time to unwind their positions.
“We think markets will force the Bank’s hand to either extend these measures or open new ones into mid-November, their hard stance on taking away the support mechanism is doing the pound no favors,” said Simon Harvey, head of FX analysis at Monex Europe. “The BoE’s actions to expand its backstop reeked of desperation.”
“Two weeks is not enough, and more needs to be done,” said Daniela Russell, head of U.K. rates strategy at HSBC. “Pension funds are taking steps to address their liquidity issues but they are currently chasing a moving target as yields have continued to rise.”
Bailey has been wrestling with the turmoil in markets since Chancellor of the Exchequer Kwasi Kwarteng announced plans for £45 billion ($50 billion) of unfunded tax cuts in an effort to boost the long-term growth rate for the UK economy.
The central bank governor told his audience that he’d worked round the clock for several nights in a row in order to devise the market intervention. The BOE did not want to buy gilts because doing so blurs the distinction with monetary policy, under which it bought £875 billion with quantitative easing.
“We have the two things working in opposite directions,” Bailey said. The BOE is raising rates and has said it hopes to start selling gilts from its Quantitative Easing program, but now finds itself buying gilts to contain instability in the market.
Officials at the bank had tried to come up with a policy that would have directly targeted stresses emerging in so-called Liability Driven Investment strategies, but they had been prevented from implementing them due to a “structural issue,” Bailey said. That had led them to introduce the bank’s initial pledge to buy long-dated gilts.
“In the end, we couldn’t make the targeted intervention into that particular sector,” Bailey said. “So we had to announce that we went by conventional bills.” The package was extended to include corporate bonds at the start of the week and index-linked gilts on Tuesday.
The BOE has previously run stress tests on potential market volatility, but the moves in the past few weeks went beyond the BOE’s worst case scenarios.
Funds have access to the liquidity they need but would have struggled to “bring it over” without upsetting markets. He said there was now “a window of opportunity for the pension funds to do this rebalancing.”
Read More: How ‘Liability-Driven’ Funds Triggered UK Bond Panic: QuickTake
Bailey also used the platform to welcome the government’s plan for growth and its decision to expose its fiscal plans to the independent scrutiny of the Office for Budget Responsibility. If the government can raise the trend rate of growth, that will help the operation of monetary policy, he said. “Bringing the OBR back is important,” he added. “Just as monetary policy has to have a framework, so does fiscal policy.”
However, he cautioned the government against pushing too hard on financial deregulation as part of its plans for post-Brexit freedoms. A key plank of the government’s supply side reforms is an unencumbered financial sector.
“Competitiveness in financial services is important. It’s important as regulator that we regulate to support sustainable growth,” he said. But equally, “having effective strong regulation is an important part of being a strong financial center.”
He also used the latest market crisis to once again call for tougher standards for the non-bank financial sector, the lightly regulated asset managers and hedge funds that sit outside banking and were the source of the latest instability.
(Updates with comment in fourth paragraph)
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