If government bond sales by pension funds are the fundamental cause of a potential systemic crisis that could hurt us all, as the Bank of England says, why are pension funds taking so little advantage of the Bank’s offer to buy £65 billion of the bonds? And why are bond prices still falling?
It seems to me the only explanation for what is happening is that margin calls on pension funds’ liability-driven investments (LDIs) – or the trillion pounds of their debt that’s secured against UK government bonds – are not, in fact, the main cause of the spike in bond yields, or at least they are only a small part of it. It is the other way round.
The spike in bond yields is prompting margin calls, which is then causing pension funds to sell assets, of which gilts are only part. This is not a market’s tail wagging the economic dog, as to an extent happened in 2007/08, but an economic dog, high on fiscal stimulus, biting off its markets tail.
Kwarteng could not survive that humiliation
If that is the case, you would not expect the pension funds to use much of the Bank of England’s £65 billion facility, because they are flogging other stuff to cover bond losses. And the worry, of course, is that the £65 billion facility – even if take-up is low – is pro-inflationary. That reduces confidence of investors that the Bank and government can and will take necessary and sufficient action to bring down inflation: the very inflation which is driving down bond prices and driving up bond yields.
Or to put it another way, the fundamental threat to financial stability stems from a mini-budget that spooked investors by stimulating inflation and creating a £60 billion-a-year black hole in the public finances, coupled with a concern that the Bank of England’s anti-inflation credentials are not what they should be.
The threat to financial stability is real enough. But the excessive debt or leverage of pension funds – a failure of regulation if ever there was one – is only a proximate trigger.
The fundamental cause is investors’ lack of confidence in the institutional competence and anti-inflationary determination of the Treasury, Downing Street and the Bank of England. This is fundamentally Kwasi Kwarteng and Liz Truss’s mess, with a bit of help from Threadneedle Street.
And the worry is that once confidence erodes, all the reverse ferrets in the world – OBR reinstated, Treasury lifer given top Treasury job, and so on – will struggle to restore it.
By the way, if the fundamental threat to financial stability is, as I argue, the unfunded tax cuts, a restoration of stability requires the Chancellor to cancel or massively delay the cuts (and increase corporation tax as per Rishi Sunak’s plan). But I don’t think there has ever been a U-turn on that scale in modern politics.
Kwarteng could not survive that humiliation. And it is not clear the PM could either, because the big money cuts were her summer leadership pledges. This is a monster of an interconnected political and economic crisis.
Comments