The Bank of England pledges to buy unlimited long-dated bonds is a sign that UK policy makers are attuned to what Bank of America has called the impossible trinity of structural problems plaguing global interest-rate markets.
Mark Cabana, head of the US interest rates strategy at Bank of America Corp., said last week there were a number of issues that affect markets, from high debt loads to the absence of central bank intervention. It was these dilemmas that forced the BOE to announce its plan to buy bonds, which had an immediate impact on the gilt market, putting yields on 30 year debt on track for the biggest drop on record on Wednesday.
The turmoil in the UK shows that conditions in the global interest-rate market are just as precarious, with the $24 trillion US Treasury market being the prime example. The Bloomberg US Government Securities Liquidity Index - a gauge of deviations from a fair-value model - is near the highest levels since the early days of the epidemic.
The central banks around the world have started shrinking their balance sheets, reversing trillions of dollars of pandemic-driven expansion at the same time they tighten policy, so global interest rates repriced sharply and most curves flattened. The Federal Reserve has been undergoing a so-called quantitative tightening since June, while the BOE was expected to begin actively selling its existing holdings of bonds Monday, though it has since delayed the program.
The poor liquidity and increased volatility had sidelined investors at Treasury's two and five-year auctions. JPMorgan strategists said Wednesday s seven-year sale would be hard to digest due to market volatility and declining liquidity over recent sessions, though buyers showed up for the offering.
There are steps that the Fed can do to improve Treasury market functioning. When the central bank exempted reserve balances and Treasuries from the supplementary leverage ratio calculation when it was precarious, the central bank exempted them from the supplementary leverage ratio calculation. The exemption, which was intended to improve dealers ability to make markets during the stressful period, expired in March 2021, but the central bank said it would propose changes to the rule.
The Standing Repo Facility was officially introduced in July 2021, and policy makers are confident that it will help keep the Treasury market functioning smoothly. Participants would be able to give the central bank their Treasuries in exchange for cash reserves, though daily operations are rarely used at this point.
Treasury Secretary Janet Yellen said Tuesday that financial markets are functioning well, but she hasn't seen any liquidity problems that could indicate financial stability risks.
Cabana isn't convinced and fears markets are trading a lot like March 2020, just without the policy backstop which in the end will require more intervention.
Cabana wrote in a note to clients that rates do not work as a hedge when risk taking is cut and liquidity is thin. We are increasingly concerned that rates markets will need more frequent CB intervention to stay liquid. None of The Supreme Court Is About to Display Its Power Imbalance Again?