There was an early warning siren six months ago in the UK about how unexpected aftershocks might suddenly be triggered by the major repricing of fixed income globally. But the resolution of that crisis offers a reassuring example of how this latest systemic wake-up call might be worked through.
The UK gilt market had an existential wobble in late September when a sleepy section of its pension system could not get out of its own way. A sudden liquidity crisis triggered by sharply rising long-maturity gilt yields nearly caused some pension funds to become technically insolvent. Since the global financial crisis, many UK pension funds have relied on a leveraged derivatives strategy known as liability-driven investments to work round the insufficient returns available from super-low bond yields. A confluence of events, not least of which was a shambolic mini-budget from the ill-fated Liz Truss administration, spilt over onto already rising gilt yields. Margin calls then led to a panic fire sale, producing an unvirtuous circle that required official intervention.
The Bank of England received a £65 billion ($78 billion) credit line from the UK Treasury to step in and become the buyer-of-last-resort. Ultimately £19 billion was sufficient to restore order, although the longer-term ramifications will take some time to be fully resolved. But the system was saved and orderly markets returned. The BOE was even able to exit its Financial Stability Intervention by January with a tidy £3.8 billion ($4.6 billion) profit. Gilt yields have returned to mostly trading beneath US Treasuries. The UK central bank has hiked its official rate three times since the LDI crisis, by 175 basis points to its current 4%, and resumed its quantitative-tightening program.
But that was very much a domestic crisis; this is a worldwide wobble, with financial stocks everywhere feeling the pain. The UK arm of SVB has also been declared insolvent. The UK government has made clear it “is treating this issue as a high priority, with discussions between the Governor of the Bank of England, the Prime Minister and the Chancellor taking place over the weekend.” Bank deposit insurance is only covered up to £85,000 in Britain and €100,000 ($106,000) in the euro area, about half the US level, so it’s likely further official support may be needed for tech firms with funds trapped in SVB units.
But the bigger macro picture will also be changed by this bank run. Of all the major central banks, the BOE was starting to tread with the most caution about tightening monetary policy further, even before SVB collapsed. BOE Governor Andrew Bailey was keen to hedge his bets in a recent newspaper interview on where borrowing costs go next. The Federal Reserve will no doubt be having a hard think about whether stepping harder on the monetary brakes is the right course of action in such a febrile environment.
The European Central Bank, in particular, ignores these alarm bells about the potential unintended consequences of rising bond yields at its peril. After eight long years of negative rates, a 300 basis-point tightening since July is probably inflicting a bigger shock on the euro zone than other economies are undergoing. The euro area was teetering on recession even before the pandemic hit, and its subsequent recovery has been sluggish. Moreover, Europe has a much bigger culture of saving via bonds rather than equities, meaning retail investors are also feeling the pain of lower fixed-income values. Discretion before ploughing ahead with several more 50 basis-point rates hikes might be prudent.
Scrutiny of the financial system everywhere will need to be tightened after SVB, to minimize the risk of further cockroaches. Over-stimulus followed by heavy braking is going to lead to some erratic driving. But the BOE’s sure-footed intervention in September shows that the authorities have a firmer grip on crisis management since the global financial crisis. Financial institutions are now much better capitalized, and regulated. Still, no system is without flaws, and what lies beneath can often get overlooked. The guardians of financial stability would do well to temper their rate-rising enthusiasm, for now at least.
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• Bond Yields Are Jumping at Fed Phantom Shadows: Marcus Ashworth
This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
Marcus Ashworth is a Bloomberg Opinion columnist covering European markets. Previously, he was chief markets strategist for Haitong Securities in London.
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