As first reported yesterday, in a striking development, the BOE failed to purchase all the longer-maturity gilts it had hoped to buy from the open market on just the second day of its restarted QE operation, as it encountered something striking: an offerless bond market.
This morning the BOE The Bank of England addressed the failure, when it said it would deal with the GBP52 million “POMO shortfall” at a later date as it made no changes to its expanded GBP60 billion quantitative-easing program.
There was no additional information provided by the BOE, which is why traders and strategists had to come up with their own explanations for what happened, and what this may mean for the future.
As Bloomberg notes, “the miss may have been partly due to thin summer liquidity, or even traders being on holiday, which means Tuesday’s issue may be a one-off.”
So… a major developed nation’s bond market is contingent on traders not being on holiday? Good luck with that. Of course, the worst case scenario is if it isn’t a “one off” (or if traders remain on holiday) which is why all eyes will be on the next auction to be held in a few minutes.
Below are some other notable reactions, fia BBG and FT:
Mike Amey, head of sterling portfolio management at PIMCO:
If they were reasonably comfortable that this was just a one-off, then the natural thing to do would be to say ‘OK, fair enough, I’ll just buy some more today and then we will move on. So I think it’s a bit more nuanced than that. And it indicates to us that it’s going to be a challenge to buy these bonds.”
The fact that the Bank of England will deal with the shortfall in 3-6 months’ time suggests that they believe there is a risk of another operation where the offers do not cover what they are looking to buy. This is most likely at the long end of the gilt market, where pension funds and insurance companies need to hold on to their bonds to meet regulatory requirements.
We think that the Bank of England will be looking to buy more than the gross supply of gilts, so it is possible that longer dated yields can fall further. The Bank should find it easier to buy shorter dated bonds, where yields are already much lower and there are fewer regulatory constraints preventing holders from selling.
Luke Hickmore, senior investment manager at Aberdeen Asset Management.
The BoE’s statement today doesn’t amount to a hill of beans. They’re saying they’ll make up the shortfall, which is actually pretty small so far, over the next six months. But that shortfall could grow. The long dated Gilts that they want are going to be challenging to get hold of.
Much of the paper of and around 15 years is held by pension funds and liability driven investors. They are holding it purely to match liabilities, the value of which is higher with every drop in yields. The BoE programme actually just makes them want more Gilts as yields continue to fall.
Darren Bustin, Head of Derivatives at Royal London Asset Management
Today’s announcement has the Bank kicking the can down the road and has created a ‘wait and see’ scenario for investors looking at reasons for the failure. As quantitive easing was meant to have been a solution for the problems facing the British economy following Brexit, if this trend continues and monetary policy is unable to achieve its goals then the baton may have to be passed to the Treasury to find a solution.
Longer term, if quantitative easing continues to fail this could mean a fiscal response such as a VAT cut of 2.5% in the Autumn Statement as the Treasury steps in. This could help to curb inflation as the Bank of England is currently forecasting medium term inflation above its stated 2% target.
Oksana Aronov, managing director at JPMorgan Investment Funds.
A negative yielding bond is, in effect, a commodity. And as Warren Buffet has said, “The problem with commodities is that you are betting on what someone else would pay for them in six months. The commodity itself isn’t going to do anything for you….”
Bonds increasingly cease to trade based on fundamentals, such as yield, and trade instead on what someone else might be willing to pay for them in the future.
This issue seems to have a relatively easy fix – why wouldn’t central banks simply raise interest rates? Let us be clear here – we absolutely believe this is a logical step for the US Federal Reserve to take. The constructive nature of US economic data is at odds with the emergency level of fed funds established in the abyss of the financial crisis.
However, while central banks have shown they are certainly capable of driving rates lower, they have yet to prove they are able to drive market rates up.
The bottom line, as we see it: In the wake of unprecedented quantitative easing, central banks may have painted themselves into a corner and lost their ability to alter market rates.
Only time will tell if central banks can find creative solutions in normalizing interest rates without disastrous side effects such as a yield curve inversion. One way or another, market forces will eventually prevail and return the income component to bonds. Until then, investors should consider diversifying into more flexible strategies with a much broader toolbox across traditional, alternative and private markets.
Markus Allenspach, head of fixed income research at Julius Baer:
There are two models for central bank purchases. The Federal Reserve bought Treasuries in auctions, which had been announced well in advance, whereas the European Central Bank pursues a clandestine approach, just publishing the aggregate amount of purchases it has conducted. The Bank of England is applying the “public” strategy, i.e. is announcing in advance when it plans to buy what amount of Gilts.
Finally, from RBC:
Bunds would probably be weaker without the gilts’ influence. Beware – gilt yields can’t fall for ever. We remain of the opinion that it is not worth chasing the rally in core bond markets.
For now, however, as yields drop to record lows and as the UK short-end dips negative, it is being chased quite furiously.
via http://ift.tt/2biHRsx Tyler Durden