UK pension funds are dumping assets to meet margin calls as the BOE confirmed it will end emergency bond buying, and the reverberations are being felt everywhere from Sydney to Frankfurt and New York.
In the US, investment-grade corporate bonds are falling, with average prices of around 86 cents on the dollar compared with 90 cents on September 21. UK pension funds have contributed to the selling pressure in recent days, according to one Wall Street trading desk.
In Europe, leveraged loans bundled into bonds known as collateralised loan obligations have been under pressure. In Australia, investors have reportedly been asked to bid on mortgage-backed securities that were being auctioned off. The yield premium on Asian investment-grade dollar notes is at a two-month high and headed for a third day of increase.
UK pensions are selling to meet margin calls on derivatives they used to help ensure they could keep paying retirees even if interest rates changed, using a technique called liability-driven investing. The offloading that first began after a spike in gilt yields two weeks ago was renewed this week, when the Bank of England confirmed that it plans to end an emergency bond buying program on Friday. Investors are hoping the central bank will back down.
“The market simply doesn’t have the confidence, for now, that the LDI crisis won’t return and has increased concerns that other pockets of leverage may cause issues,” Janusz Nelson, head of Western European Investment Grade Corporate Syndicate at Citigroup Inc. said. “Until we see some stability in the rates market, wherever that may come from, investors will continue to be nervous around their holdings.”
End of intervention
The Bank of England had hoped its bond-buying support measures would create a bazooka so big that nobody would be in any doubt that they would intervene to quell market turmoil, according to a person with knowledge of the matter. Limits on the buying were increased to allay any concerns that anyone seeking to tap the program this week would have difficulties accessing it, the person said, asking not to be identified as the matter is private.
Then traders grew concerned about the end of BOE intervention. Yields on UK government securities tied to inflation, known as linkers, moved out again. Yields on sterling denominated investment-grade corporate bonds ballooned to over 7% for the first time since 2009. Their fears intensified on Tuesday when BOE Governor Andrew Bailey warned that the program will end on Friday. The next day, the BOE made its biggest round of emergency purchases since the intervention began last month.
But the selling pressure in recent sessions has been spreading to other parts of the world as well. UK markets have been in a tailspin since Chancellor of the Exchequer Kwasi Kwarteng presented a package of unfunded fiscal stimulus on September 23.
“Investors fear further selling from UK liability-driven investment managers in response to margin calls, including selling of USD high-grade credit,” JPMorgan Chase & Co. strategist Eric Beinstein wrote Wednesday. “There was some evidence of this selling yesterday.”
That selling was manifest in risk premium movements. On Tuesday, US investment-grade bond spreads widened five basis points, according to Bloomberg index data. But the Markit CDX North American Investment Grade Index, a proxy for credit risk, widened just 1.9 basis point. Similar underperformance of cash bonds happened two weeks ago when the UK pension issue first flared up, JPMorgan’s Beinstein wrote.
The end of forward guidance by central banks has roiled market strategies based around buying the dip and selling volatility on the assumption that correlations would continue to be stable as they had been for two decades, said Alberto Gallo, co-founder of hedge fund Andromeda Capital Management. Risk parity strategies and 60-40 portfolios are among those that could be vulnerable, he said.
“What’s happening in the UK could lead to further volatility also in the Eurozone market,” said Gallo, who previously ran money for Algebris Investments. “There’s a lot of assets that should not be priced where they are now. We’re just at the beginning.”
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