Bond Market Insights - Thurs, 29 Sept 2022

The scale of the UK Gilt market rout that was close to wiping out pension funds can be demonstrated by UKT 1.25% 2051 sank to around at 42.85, a yield of 5.025%, the highest since 1998. In December it had been trading with a 110 handle. 5 hours later it was trading almost 12 points higher in price, yielding 3.92% as BoE stepped in to stabilize the market, buying about GBP1bn of gilts according to dispatches.


It seems strange to hear that UK Pension Funds are facing margin calls, since they are supposed to match liabilities, but it transpires that pension funds, particularly final salary schemes, use Liability Driven Investment funds that have a gross value of roughly GBP1.5 trillion, of which GBP 1 trillion has been invested in Gilts and other bonds. The funds repo their gilt holdings and re-invest time and again. Variation margins must be topped up as collateral valuations fall and there is the crux. The problem has been a long time in the making. Zero rates over a prolonged period have forced pension funds to become more creative in their investments to meet liabilities, the rapid fall simply brought these to light.


I did find it amusing to read a missive from one of our LATAM brokers. They grouped the UK with other EM such as Brazil, Kenya and Chile. Despite all these headlines it must be remembered that U.K. is the sixth largest economy in the world, and its pension fund system has 3 trillion pounds in assets.


According to the Australian Financial Review Aussie superannuation funds faced similar issues in 2008 and again in March 2020, as currency hedges on foreign assets were impacted by the falling AUD. They opine that this could again be a threat.


Back in Asia IG is looking better this morning after yesterday’s fall. China AT1 are 1pt higher on short covering, while CDS gapped tighter. Following yesterday’s tumble CIFI Group is reported to be in talks with trustees over solutions for early liquidation of investment products. There was a bit of calm as they made prompt payment of CIFIHG 6.55 03/28/24’s September coupon.


The IG rally lost steam as we headed into lunch with sellers taking the upper hand. Now 1-2bps tighter in beta, unchanged for quality issues. AT1s and Perpetuals pulled back to up 0.25pt, but there is no material buying. Some off-the-run perps are without bids. Some HKAA perps traded as much as 1.5pt lower. Southeast Asia had an early round of selling which took prices to levels lower than yesterday pre-BOE intervention.


There are some dealer casualties amidst all this movement. European financial bonds heavily underperformed with Senior spreads 10bps wider vs. Sovereign bond benchmarks. As an example Banca Monte Dei Paschi di Siena Seniors were around 30bps wider while synthetics closed tighter, along with iTraxx, nasty for those who hedged positions with CDS.