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UK bond market chaos sends investors fleeing

pound sterling

Investors piled cash into sterling money-market funds at more than three times their usual rate during the recent turbulence in British bond markets, and pension funds likely made up the bulk of those inflows, Fitch Ratings said on Friday.

The government’s “mini-Budget” on Sept. 23 triggered some of the biggest ever jumps in UK government bond yields, spooked wider markets and triggered a crisis among pension funds needing to find cash.

Money market funds typically invest in high quality assets over a shorter-term horizon than other asset managers and, as such, are perceived to carry lower risk.

Fitch warned that if the volatility in British gilts persisted or intensified, “liquidity pressure” could spread beyond pension funds.

“Corporates that sponsor pension funds could face associated liquidity needs, as could entities that borrow on a margin basis, such as hedge funds that borrow using repo,” Fitch said in a note, referring to a form of short-term borrowing.

The agency noted that such a development could lead to sudden large redemptions of cash from money market funds (MMFs).

The Bank of England’s Temporary Expanded Collateral Repo Facility, launched on Oct. 10, is a key part of the BoE’s plan to avert further turmoil in money markets after it stops buying UK government bonds on Friday.

Banks offering the facility can pledge an expanded range of pension funds’ assets with the BoE in return for short-term loans that can then be channelled back to a cash-poor pension fund’s so-called Liability Driven Investment (LDI) manager.

Fitch said it believed most of the increase in recent inflows in MMFs was down to pension funds building up cash given an increase in collateral requirements from many LDI funds.

The maximum daily inflow at a fund level among Fitch-rated sterling short-term money market funds (MMFs) peaked at 17 per cent of assets under management on Sept. 30 compared with a usual level of around 5 per cent, the ratings agency said in a note.

“The maximum daily outflow was relatively stable at the time, although outflows have increased for some funds more recently,” Fitch said, adding that it expected inflows and outflows to be volatile given uncertainty over the BoE’s willingness to further support the gilt market.

Gilts rallied on Friday after finance minister Kwasi Kwarteng cut short his trip to the International Monetary Fund in Washington to return to London in the face of pressure to reverse his tax plans.

Ten-year gilt yields were down 17 basis points on the day at 4.022 per cent and 30-year yields – hardest hit by the sell-off since the mini-budget – were 14 bps lower at 4.41 per cent.

Still, 30-year gilt yields are up 60 bps this month, versus a rise of 12 bps in US and German peers.

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