It has been another day of turmoil in financial markets, with some hefty moves after the BoE intervened to support the UK gilts market. The intervention triggered a big turnaround in the global rates market, with flow-on effects in the currency and equity markets. The UK 10-year rate is down 50bps on the day, with the US 10-year rate down over 20bps. The S&P500 is on track to break a run of daily declines, and higher risk appetite has driven the USD lower. The NZD has been one of the biggest beneficiaries, surging nearly 3% after probing fresh lows.
The UK remains the centre of the market’s attention as the country faces a combined energy, fiscal, and balance of payment crisis and credit crunch, much of it self-inflicted by poor policy decisions over recent years, weeks, and days. After sitting back and watching rates surge, the Bank of England released a statement of its concern for the function of the UK debt market and it stood ready to restore order to reduce contagion risk to credit conditions for households and businesses.
To achieve this, it would conduct purchases of long-dated UK gilts “on whatever scale necessary” and “time-limited” through to 14 October. The operation would be fully indemnified by the government. The Bank also postponed the beginning of QT (the annual target £80b of stock reduction, with active sales of £40b) to 31 October. Given the prevailing market conditions, the Bank was looking to purchase nominal gilts with residual maturity of more than 20 years in the secondary market, initially at a rate of up to £5 per day. These parameters would be kept under review.
As noted the in the FT, the BoE’s intervention followed days of intense pressure on UK pension funds that are normally buyers of gilts. The funds with so-called liability-driven investment (LDI) schemes were facing margin calls as yields surged higher, making them forced sellers in the market to top up collateral, and thereby creating a vicious cycle in the gilt market.
The BoE’s actions triggered a significant fall in UK rates, which has reverberated across other markets. On the day, the UK 2-year gilt is down 40bps, the 10-year rate is down 50bps and the moves have been even larger at the long end, which the BoE’s market operations are focused on, with 30-50 year rates down between 106-113bps. GBP was volatile and plunged from around 1.07 to 1.055 at its low, before staging a strong recovery through to about 1.09.
Some investors are wondering why GBP hasn’t cratered, given this is a step towards the BoJ’s operating model, where the government and central bank are joined at the hip, with the central bank ending up propping up the bond market. It certainly raises a lot of questions about the direction of UK policy, but for now the market is willing to cut the BoE some slack and argue that it was a necessary intervention to protect a market that had become seriously disorderly.
The BoE’s actions spilled over to other markets, reminding investors of the power of central banks and how they can be easily persuaded to change their mind on the flip of a dime. It was only 24 hours ago that BoE Chief Economist Pill was indicating, as we reported yesterday, that QT would soon begin if market pricing stayed orderly “as has been the case in recent days”, a remarkably ignorant comment that had led to a further ramp up in rates.
The market has pared back some of the expected policy tightening priced into the Fed Funds curve and US Treasury rates have fallen across the curve, with the 2-year rate down 17bps on the day and the 10-year rate down 21bps to 3.74%, after trading higher to just above the 4% in late Asian trading.
Risk appetite soured yesterday afternoon after reports that Apple was backing off plans to increase production of its new iPhones this year after an anticipated surge in demand failed to materialise. US equity futures headed south on that news, but the BoE’s intervention triggered an improvement in risk sentiment, and the S&P500 is currently up 1½%, breaking a chain of daily losses.
The USD shows broad-based weakness, with the DXY index down 1.2% on the day. As risk appetite soured, the NZD hit a fresh 2½-year low of 0.5565 yesterday afternoon, but the BoE’s intervention triggered a powerful recovery, currently up around 0.5720, up nearly 3% from the low. The AUD follows a similar pattern, up from a low of 0.6363 and now around 0.6520. Both the NZD and AUD were dragged lower as the yuan came under attack yesterday. USD/CNY broke above 7.20 with ease and went on to trade as high as 7.25. The PBoC fired another salvo trying to support the yuan, releasing a statement saying “do not bet on one-way appreciation or depreciation of the yuan, as losses will definitely be incurred in the long-term”. USD/CNY has since fallen back to 7.20.
EUR is up around 2 cents from its low to 0.9730, a beneficiary of the rebound in GBP and some hawkish ECB rhetoric helping at the margins. Latvia’s Kazaks argued for a 75bps hike at the October meeting, saying the “next step still has to be big, because we are still far away from rates that are consistent with 2% inflation”. Austria’s Governing Council member Holzman also favours 75bps, arguing that a jumbo 100bps hike would be “currently too much”.
JPY has been the least moved by the unfolding drama seen elsewhere in markets, with USD/JPY down only about 0.5% to 144.
In economic news, the US goods trade deficit narrowed to $87.3b, its lowest in nearly a year, nearly $2b smaller than expected, which will support the net exports contribution to Q3 GDP. Normal service was resumed on US housing market data, following yesterday’s positive surprise to new home sales, with pending home sales down 2% m/m in August, the ninth drop of the past ten months and now down 28% from the peak.
Domestic rates were pushed higher yesterday by global forces, the US 10-year’s first touch of the 4% handle coming ahead of the NZ close. Swap rates closed up 6-8bps, with all rates at fresh highs for the cycle. NZGB rates were up 3-5bps, with the 10-year rate closing at an 8-year high of 4.34%. Since the NZ close, the Australian 10-year bond future has fallen 21bps in yield terms, setting the scene for a significant fall in NZ rates on the open.
In the day ahead, the ANZ business outlook survey is expected to show a lift in own activity expectations, off a low base, which would be consistent with the recent improvement seen in BNZ’s PMI and PSI indicators. German inflation data tonight is expected to show annual CPI breaking up through 10% for the first time this cycle.
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