Speaker 1: I'm Francie Laqua and I'm David Merritt, and this is
Speaker 1: in the City, Bloomberg's podcast, connecting you to the stories
Speaker 1: and the voices at the hard the City of London.
Speaker 1: And right now we're going to be recording another bonus episode.
Speaker 1: So much news coming thick and fast. We just had
Speaker 1: to tackle this subject today. There are huge moves happening
Speaker 1: in the U K's guilt market. In fact, some are
Speaker 1: saying that market is crumbling. Yeah, could I just say
Speaker 1: that bonds are meant to be boring? They are francy,
Speaker 1: you know, they're that exciting. So we'll go to try
Speaker 1: and really break it down to make everyone understand what
Speaker 1: we're dealing with and what the wayfold is for the
Speaker 1: Bank of England. In the studio, we're joined by Christina Kino,
Speaker 1: Managing Editor of Markets and Lucia gift Apolo Asset Management Report.
Speaker 1: Although we're calling her a pension queen, right because it's
Speaker 1: all about pensions this week, right, I mean all the
Speaker 1: danger they were in, I mean that's how bad things got. Yes,
Speaker 1: I think they have become quite sexy the last few days.
Speaker 1: Defined benefit pension funds, which are the funds that guarantee
Speaker 1: savers a set payment when they retire, so regardless of
Speaker 1: the swings of the market, they a couple of weeks
Speaker 1: ago they just found themselves into a death spiral where
Speaker 1: they were causing their own demise. They were facing margin
Speaker 1: calls and as a result they had to sell these
Speaker 1: long dated bonds which took the price much lower, and
Speaker 1: then they had to pay more in collateral, so they
Speaker 1: kind of got into a situation with the Bank of
Speaker 1: England had to come in and save them, so a
Speaker 1: death it was literally a death sparal. So these things
Speaker 1: could have actually gone out of business. So people's people's
Speaker 1: actual pension savings are on the line here. Well in
Speaker 1: a way, yes, so they they use some type of
Speaker 1: derivatives to do that and these the funds that they
Speaker 1: use would have had to be liquidated. Now whether the
Speaker 1: pension funds would become solvent is a different question, and
Speaker 1: it's not certain they would have, but they would have
Speaker 1: major life. Has this ever happened in the UK before
Speaker 1: in the pension industry, No, it hasn't to my knowledge.
Speaker 1: In the last so the strategy exists for twenty years
Speaker 1: and it's the first time they've been that people found
Speaker 1: out there is this thing actually exists. But but this,
Speaker 1: I mean, the point is that we had forty eight
Speaker 1: hours of complete chaos in guilds. But this is should
Speaker 1: be low risk investing. And once again, and this is
Speaker 1: usually how crises started. Once again, it's slow risk investing.
Speaker 1: You know, these strategies that are anything but low risk.
Speaker 1: So what did we get wrong? I think that these
Speaker 1: were meant They worked very well in a kind of
Speaker 1: low rate environment where they were not wild market moves.
Speaker 1: But once they started, they couldn't control it because they
Speaker 1: hadn't faced it before. Some people, some consultants, have said
Speaker 1: that the volatiles broke through this model that had worked
Speaker 1: fine for the past twenty years, and now they don't
Speaker 1: know if going forward they can actually use this in
Speaker 1: the way it is right now. I just starting it
Speaker 1: back bit here, maybe bringing in Christine just Um where
Speaker 1: this all began with. We've got a new government in Britain,
Speaker 1: new Chance to the Exchequer, that what they're calling their
Speaker 1: pro growth Agenda. They announced a huge slew of tax cuts.
Speaker 1: It freaked out the markets, but the place it freaked
Speaker 1: them out most was in the government bond market or
Speaker 1: the guilt market. Wasn't it. Can you explain a little
Speaker 1: bit to us more broadly why that happened and how
Speaker 1: do we get to this point where actually everyone's pensions
Speaker 1: on the threat. Well, if I think what we saw
Speaker 1: on bond markets is essentially investors going up in arms
Speaker 1: over the UK's fiscal plan. They're calling it a pro
Speaker 1: growth plan, but what they're really doing is spending more,
Speaker 1: cutting taxes and doing it in such a way where
Speaker 1: it's going to be unfunded, i e. They're going to
Speaker 1: have to increase the amount that they're going to be
Speaker 1: borrowing from public markets over the next few years. Now.
Speaker 1: They justified this and they sort of interrupted. They said, look,
Speaker 1: the market can take more borrowing. They said, Britain's got
Speaker 1: one of the lowest debts of g D p R
Speaker 1: shows of the G seven. You know what we can
Speaker 1: we can afford to borrow it more. But they got
Speaker 1: that wrong, right, Yeah, because I think the other side
Speaker 1: of this, so that's one side of it, right, is
Speaker 1: the fiscal approach, and this is what the UK plans
Speaker 1: to do. And yes, maybe in a vacuum, you would
Speaker 1: think that the government, or or rather the bob market
Speaker 1: in the UK has the capacity to absorb more debt.
Speaker 1: But the other side of this is very important, it's
Speaker 1: the monetary policy side of it. We are in an
Speaker 1: environment of a rising rates and rapidly so in the
Speaker 1: Bank of England already behind as it is versus other peers,
Speaker 1: was going to have to scramble to raise rates a
Speaker 1: lot more to get ahold of inflation. And suddenly you
Speaker 1: have monetary policy and fiscal policy clashing majorly, which really
Speaker 1: what the bond markets was up in arms about. So
Speaker 1: look it was this really a miscalculation from the government.
Speaker 1: As far as anyone can remember or recall, the UK
Speaker 1: run a deficit on its current account, which means that
Speaker 1: the nation, as Mark Arney said, relies on the kindness
Speaker 1: of strangers. Those strangers or investors. I mean for the
Speaker 1: long dated bonds, the main investors are the pension funds,
Speaker 1: and this was one of the problems that there were
Speaker 1: no natural buyers, so no one was going to buy
Speaker 1: when they were selling because they the long dated bonds,
Speaker 1: which are the bonds that would mature in like twenty
Speaker 1: thirty years, they mainly owned by these pension funds. I
Speaker 1: don't know if anyone had thought that this was a
Speaker 1: possibility in life that this this thing could actually happen
Speaker 1: and it would just be another obscure part of the
Speaker 1: market that would blow it all up. But was there
Speaker 1: also a liquidity problem which regulators are now looking into.
Speaker 1: There were liquidity problems because the pension funds had to
Speaker 1: come up with collaterals so fast that they actually not
Speaker 1: have time to sell any assets. So they would have
Speaker 1: to come up with collateral in three or four hours
Speaker 1: when they usually have ten days to do so, and
Speaker 1: they were just they had assets to sell. They were
Speaker 1: liquid in the sense that they had equity to sell,
Speaker 1: they had bonds to sell, they just did not have
Speaker 1: any time to sell them. So we had emergency action
Speaker 1: from the Bank of England to try to try to
Speaker 1: stop the panic. We've had them again this morning, we're
Speaker 1: recording this on Tuesday morning. We've had them again coming
Speaker 1: out and stepping into the market to try and stabilize
Speaker 1: things because yesterday on Monday, we saw this huge, i
Speaker 1: think record increase um in the yields on inflation linked gilts. Christine,
Speaker 1: can you explain a little bit about what happened yesterday
Speaker 1: in the historic move Well, I think what we saw
Speaker 1: yesterday it was precisely the dynamic that Lucia was describing. Right,
Speaker 1: you suddenly had this massive sell off in this part
Speaker 1: of the market that is usually very sleepy, Dave, this
Speaker 1: doesn't happen on a normal day, but we finally saw
Speaker 1: it happened because all of these pension funds that had
Speaker 1: to dump their assets, right, they are mainly the biggest
Speaker 1: buyers of these inflation linked bonds and suddenly they're having
Speaker 1: to sell these and that create did the spiral of
Speaker 1: a sell off in this market. Investors or maybe third
Speaker 1: party observers are suddenly seeing, oh my god, there's a
Speaker 1: sell off. We better get in on this before we
Speaker 1: get burnt, and that kind of just causes the spiral,
Speaker 1: the death spiral that the Lukia had mentioned. And again
Speaker 1: this is why probably we're seeing the Bank of England
Speaker 1: having to step in, what for the second time in
Speaker 1: two days. You know you've covered markets for many years here, right,
Speaker 1: have you ever seen, especially in the boring guilt market,
Speaker 1: these sorts of moves ever before? No, not in my lifetime,
Speaker 1: and I've been in this market for more than a decade,
Speaker 1: aging myself a little bit here. Uh No, this is
Speaker 1: really unprecedented at least in the modern ages. And I
Speaker 1: think this is precisely why investors in the Bank of
Speaker 1: England alike are probably really really worried. Right now, can
Speaker 1: you explain to understand what was really at work? Maybe
Speaker 1: we need to also understand these liability driven investments, right
Speaker 1: That's useful because it means basically that pensions funds have
Speaker 1: to have enough roll re liability to cover it. Dear lord. Yes,
Speaker 1: so this is l d I is something that has
Speaker 1: now become the words people talk about. The three weeks ago,
Speaker 1: I know when when it actually happened, I had investment
Speaker 1: managers calling me and saying, what the hell is that?
Speaker 1: They were googling explainer as to try and understand, and
Speaker 1: then they were trying to kind of explain it, but
Speaker 1: we have to explained around the podcast. Yes, So basically
Speaker 1: this is a type of derivative trade that pension funds
Speaker 1: used to match their liabilities and their assets so they
Speaker 1: have more money to invest in growth assets. So once
Speaker 1: they are they have enough guilts to pay out their
Speaker 1: liabilities in twenty thirty years time, when the when when
Speaker 1: people in the scheme will will be retired, they can
Speaker 1: use assets to actually you know, grow grow the money
Speaker 1: that they have. When one prices fall, they have to
Speaker 1: pay collateral, and when they rise, they get collateral. On
Speaker 1: this occasion, they fell, and they fell steeply, and they
Speaker 1: fell fast, so they had to pay a lot of
Speaker 1: money very fast. As a result, they now need to
Speaker 1: have multiple amounts of cash of what they had before
Speaker 1: to be able to withstand very very wild variations in
Speaker 1: the market. So they're now selling everything they have to
Speaker 1: come up with the cash. So you could argue that
Speaker 1: at some point this was going to combust anyway, and
Speaker 1: the mini budget was the fire that lit it. I
Speaker 1: think yes, I think if people have thought the various
Speaker 1: different scenarios of it, they could have decided that this
Speaker 1: is the case. But no one was thinking about that
Speaker 1: during the very long bull market and low interest rate.
Speaker 1: So it's it's been a wake up call, I think
Speaker 1: for everyone involved. So thinking about the real world, if
Speaker 1: you like impact, there's some people listening to this what
Speaker 1: we're talking about here might find all they're still pretty obscure,
Speaker 1: you know, moving around these derivatives and the guilt and
Speaker 1: the yield and the price action. What does it mean
Speaker 1: for people's pensions, for people's savings, for people's mortgages. Well,
Speaker 1: I think that these are kind of three different things.
Speaker 1: But one thing is that these chaos is now spelling
Speaker 1: into other asset classes. So we've seen a sell off
Speaker 1: in corporate bonds, we reported a sell off in multi
Speaker 1: asset funds, and I'm sure there is a lot more
Speaker 1: happening that we haven't yet reported. So this will affect
Speaker 1: the prices of other assets that are in people's pensions
Speaker 1: as well, including not defined benefit but benefit but other schemes.
Speaker 1: Then for for defined benefit schemes, I think every everyone
Speaker 1: I speak to they try to downplay a bit. They say,
Speaker 1: we're you know, there are no solventcy issues here, we're
Speaker 1: very well liquidated, but we do have to re balance hugely.
Speaker 1: I don't know if any of the big schemes will implode,
Speaker 1: and I would be very worried to say, to make
Speaker 1: an assertion like that, but you know, when yields go up,
Speaker 1: the mortgages go up, so people will have to pay
Speaker 1: a lot more. I think it was a shock. I'm
Speaker 1: not sure how long it will take to manage, because
Speaker 1: we've see now the Bank of England doesn't think it's
Speaker 1: time for it to leave yet, So yes, I mean,
Speaker 1: savers and and and people who have to pay mortgages
Speaker 1: are a bit worried. But there's so much money in
Speaker 1: pensions on there. You know. It's the ripple effects sore
Speaker 1: as you're talking about these these these kind of fire
Speaker 1: sales of other assets that's going to ripple through the
Speaker 1: economy in ways that maybe we can't really protect at
Speaker 1: the moment. Yes, I don't think we can't because it's
Speaker 1: only just started, and investment managers generally say we will
Speaker 1: see this unfolding over the next several weeks. So I
Speaker 1: think it's too early to say with certainty this is
Speaker 1: going to happen that The signs so far are this
Speaker 1: is filling into other parts of the market, Christine, when
Speaker 1: you look at guilts, this is my cf A level
Speaker 1: twenty five. They're so crazy, right, some of the movements
Speaker 1: are so crazy. And the Bank of England has stepped
Speaker 1: in three times to change the parameters to try and
Speaker 1: stabilize them. It hasn't worked. What do they need to
Speaker 1: do for them to you know, stabilize well, for I
Speaker 1: think we could possibly be looking at whatever it takes
Speaker 1: sort of moment here for the Bank of England, because
Speaker 1: so far they've really been on kind of defensive mode.
Speaker 1: You know. They they look at the market reaction, they
Speaker 1: decide to do something in response. The market doesn't really
Speaker 1: um respond all that well, or at least the way
Speaker 1: that the Bank of England intended, and then that necessitates
Speaker 1: even more action from the bank. I think what markets
Speaker 1: are really looking for is really decisive action. They may
Speaker 1: be looking for something more broad in longer term, but
Speaker 1: do they need to persist with the backstop for you know,
Speaker 1: much longer than actually the end of this week, possibly
Speaker 1: into that November the third Bank of England decision where
Speaker 1: we could see a steep interest rate hike. That's certainly
Speaker 1: one of the initial steps that we're hearing from investors
Speaker 1: that could potentially calm the market, extending the length of
Speaker 1: this backstop um from the current endate, which is meant
Speaker 1: to be this week. But then also I think this
Speaker 1: goes back to the very heart of the trajectory of
Speaker 1: Bank of England policy itself, and we were talking about
Speaker 1: a bank that is meant to be tightening policy. They're
Speaker 1: meant to be raising rates, they're meant to be embarking
Speaker 1: on the quantitative tightening process, or you know that process
Speaker 1: of uh, the rolling off bonds from its balance sheet
Speaker 1: after such a long time of buying them, that might
Speaker 1: all be thrown into question because of the extent and
Speaker 1: the speed of what we've seen in terms of the
Speaker 1: market meltdown and the very real implications that it has
Speaker 1: for dependence industry. Yeah, that's been it's been the quantitative confusion.
Speaker 1: It's been called. Right, they're supposed to be ending quantity
Speaker 1: of easing with quantity of tightening and then suddenly they're
Speaker 1: going back to easy again. And there really is a
Speaker 1: credibility problem here, isn't It's interesting as you say, we
Speaker 1: need whatever it takes moment right, that's Marrow Draggy And
Speaker 1: of course, the last time if you look at your
Speaker 1: WB function on your Bloodbog terminal, last time you see
Speaker 1: those sort of bond moves for government bonds across Europe,
Speaker 1: w for world bonds, for well bonds, thank you very
Speaker 1: much on your nearest Blindbog terminal. That was back in
Speaker 1: the in the debt crisis in Europe, right when Maryo
Speaker 1: Dragging had to step up and say I will do
Speaker 1: whatever it takes to save the euro Can you see
Speaker 1: Andrew Bailey coming out to the steps to the Bank
Speaker 1: of England and making some sort of dectoration. Well, that's
Speaker 1: certainly the hope. We don't know if that will actually happen.
Speaker 1: I would love to see it happen, because we're right
Speaker 1: outside the bank didn't spend a single euro sent back then,
Speaker 1: right where they've already spent, and the market is testing,
Speaker 1: testing and testing. Yeah. Well, this is the legacy of
Speaker 1: quantitative easing, and you know this whatever it takes moments
Speaker 1: and that Mario Draggy kind of laid out as an
Speaker 1: example of the rest of the policymakers in the world, right,
Speaker 1: I mean he managed to do it back then. Um,
Speaker 1: this is more than a decade ago now, but the
Speaker 1: stakes have been raised since then. Uh, probably because we
Speaker 1: have been so used to such a long time of
Speaker 1: really low rates, really easy monetary policy, very supportive central banks. Uh.
Speaker 1: But that is all getting behind us now. You know,
Speaker 1: we're entering a new era where center banks are really
Speaker 1: prioritizing inflation potentially over growth, and they may not necessarily
Speaker 1: uh be you know, it may not necessarily be a
Speaker 1: contentious thing to see our recession as a result of
Speaker 1: these efforts to control I mean, you know, with a
Speaker 1: we've got a chancellor who said, you know, in the
Speaker 1: initial term or after as many budgets said, the markets
Speaker 1: will do what the markets do. I wonder how long
Speaker 1: that can hold if things continue to spiral. And as
Speaker 1: you if you say, if there's even a possibility of
Speaker 1: a big pension fund in danger, I mean, surely it's
Speaker 1: not just the Bank of Imman need to do something here, right,
Speaker 1: It's the Treasury and the government as well, isn't It
Speaker 1: isn't a question they need to get their act in order.
Speaker 1: But I know that day and speak from the same hymnsheet.
Speaker 1: Um so I think it's a problem that needs to
Speaker 1: be dealt with. We kind of know that there's a
Speaker 1: lot of lobbying going on to find a way forward,
Speaker 1: at least on the pen inside. We don't really know
Speaker 1: yet where this is going to lead, but there will.
Speaker 1: The things need to change because no one guarantees we're
Speaker 1: not going to go through the same forty eight hours
Speaker 1: of chaos, which might be a week of chaos. They
Speaker 1: say they're better prepared, but cash can only last you
Speaker 1: that long. If it's not two days and it's five days,
Speaker 1: then a lot of the selling has left funds with
Speaker 1: many liquid assets like private equity, private credit, infrastructure. These
Speaker 1: are very hard to sell assets, so I'm not sure
Speaker 1: what is going to happen if they are completely dried
Speaker 1: of cash. Thank you both for joining us, Thanks for
Speaker 1: listening to this week's bonus episode of in the City,
Speaker 1: and we will be back later in the week, but
Speaker 1: in the meantime, if you like our show, please head
Speaker 1: on over to Apple Podcasts or wherever you listen to podcasts,
Speaker 1: rate review, and subscribe, and also definitely sign up for
Speaker 1: our newsletter, The Readouts with Legra Stratton on blud dot com,
Speaker 1: Slash Newsletters, or check out the show notes for a link.
Speaker 1: This episode was hosted by me Francin Laqua and Me
Speaker 1: David Merritt. It was produced by Summer Sadi and special
Speaker 1: thanks to Christine Aquino and Lucia gift Alo.