Bank of England Governor Andrew Bailey’s blunt warning that fund managers have to cut vulnerable positions before the central bank ends debt purchases pummeled UK gilts and sent a shiver around already-fragile global bond markets.
UK government bond yields rose, with the rate on 20-year gilts reaching the highest level since the Lehman crisis in 2008, as the strict deadline forced investors to brace for another wave of selling from British pension funds managing £1.8 trillion ($2.86 trillion) in defined-benefit schemes. These funds, which hold assets ranging from US Treasuries to European corporate bonds, are expected to exit positions that were only tenable because the BOE stepped in last month to support the UK gilt market.
“The gilt selloff is putting upward pressure on bond yields from German Bunds to Italian BTPs, but more than that, investors are closely watching a central bank that is facing a major credibility test,” said Frederik Ducrozet, a senior strategist at Pictet Wealth Management. “In this broader environment of fiscal action, the big question is whether central banks will be in a position to tighten policy when government spending is rising,” he added. He said that the US Federal Reserve and the European Central Bank will both face similar challenges, with deep implications for bond markets globally.
UK long-dated government bonds slid and the pound briefly erased gains after the BOE confirmed on Wednesday that it plans to end its bond-buying intervention on Friday. There had been confusion over the BOE’s willingness to extend the Friday deadline earlier after a Financial Times report.
The chaos has been damaging for British companies who need to borrow money. An index of sterling-denominated corporate bonds, a large chunk of which comprises UK-domiciled companies, saw its average yield reach a new 13-year high of 7.14%. There hasn’t been a new corporate sterling bond deal in the market since September 20.
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Central banks have turned this year from guardians to grinches when it comes to markets, driving bonds into the first global bear market in at least a generation as they prioritize the battle to quash inflation.
“The global message may be that markets must unwind trades that are going to fail anyway as rates rise and stay high, with a brief central-bank backstop,” Michael Every, a global strategist at Rabobank in Singapore, wrote in a note to clients in regards to Bailey’s comments. “Perhaps the BOE is sending the united message that the game has changed, Volcker-style.”
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The global financial turmoil is spurring contagion concerns, especially for less liquid markets, according to Laura Fitzsimmons, executive director of macro rates and FX sales at JPMorgan’s Australian unit in Sydney.
The impact has ranged from Australia’s A$277 billion ($250.13 billion) market in securitized debt assets to the European corporate bond markets, where the average yield hit its highest level in a decade earlier this week, according to an index of investment-grade company debt.
“What is happening with the BOE is adding more volatility when we really don’t need it,” said Pauline Chrystal, a portfolio manager at Kapstream Capital in Sydney.
Spreads of asset-backed securities and mortgage-backed securities have widened in recent weeks as a number of investors tapped dealers about potential sales of their holdings after UK pension funds were forced to sell down some assets to meet margin calls, Chrystal said.
Yield premiums on Asian high-grade dollar notes widened at least two basis points Wednesday, according to traders. Global credit spreads for such debt across currencies were only one basis point below their year-to-date high on Tuesday, a Bloomberg index shows.
Elsewhere in credit markets:
EMEA
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There were seven issuers selling a minimum of €3.5 billion ($4.89 billion) of notes in Europe’s primary bond market on Wednesday.
- Agence Francaise de Developpement EPIC and Caisse des Depots et Consignations are seeking sustainable issues while Bayerische Landesbank is planning a green deal
- Other issuers include Slovakia, Commonwealth Bank of Australia, and Hypo Vorarlberg Bank AG
- The week so far has already seen more than €20 billion of sales, largely due to a €11 billion bond for the European Union on Tuesday
- Strategists from Bank of America Securities said that debt issuance in the euro area is likely to break records next year as governments scale up their spending to shelter their citizens from the energy crisis and their economies from recession
Asia
China’s crop and seed products seller Syngenta Group was the only issuer that braved the market on Wednesday for a dollar bond amid widening credit spreads.
- Yield premiums on Asian investment-grade dollar bonds are on track to rise for second session to the highest since August, with markets jittery after the BOE pledged to end emergency gilt purchases
- International issuance almost came to a halt while domestic note sales are trickling in, with a Malaysia Ringgit deal for United Overseas Bank Malaysia Bhd, a Singapore dollar bond for Koh Brothers Group Ltd., and a New Zealand dollar issue for its Local Government Funding Agency
- Global borrowers including Shinhan Bank Co. and Thermo Fisher Scientific Inc. are adding to the most yen bond sales in three years, taking advantage of the country’s lower borrowing costs amid a global fixed-income rout as central banks elsewhere raise rates to fight inflation
US
Market players in the US primary bond market were expecting a light week for supply with around US$15 billion ($21.57 billion) of high-grade sales.
- US corporate-bond issuance has become tougher to predict amid a spike in volatility, leading dealers to overestimate volume in four of the last nine months, according to data compiled by Bloomberg
- New debt offerings could follow after issuers such as Citigroup and JPMorgan release bank earnings
- Banks finally wrapped up a $2.25 billion debt deal consisting of a leveraged loan and junk bonds for Latam Airlines Group SA after they struggled to find buyers for the company’s bankruptcy exit financing
- Meanwhile, Nielsen Holdings Plc’s roughly $9 billion buyout debt structure was finalized including a revolving facility, term loans and a bridge-to-bond financing
