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Gilt yields soar out of control before Bank of England steps in

Gilt yields soar out of control before Bank of England steps in

07 Oct 2022

View the PDF and our 'Gilts Special' here

Quarter in Brief

  • Long dated gilt yields rise and fall by 1% within the space of a single week at the end of September
  • The Bank of England had earlier raised the Bank rate by 0.5% to 2.25%, their highest levels since the global financial crisis. The Fed and the ECB both raised rates by 0.75% over September
  • UK equities and corporate bonds slid as Sterling slumped to a record low against the Dollar
  • Large rises in gilt yields have seen aggregate UK DB pension scheme funding positions continue to improve

On 23 September the new Chancellor of the Exchequer unveiled his plan to stimulate growth in the UK economy in the now infamous ‘mini budget’.

The International Monetary Fund (IMF) were quick to publicly criticise the package of unfunded tax cuts announced by Kwasi Kwarteng which
it believed would “likely increase inequality”. Sterling sank to $1.03 against the Dollar amid concerns over the implications of the proposals on the long-term cost of UK government borrowing as gilt yields were sent sky-rocketing.

Pension schemes, the largest holders of UK government debt, became forced sellers of gilts and other liquid assets to meet collateral calls on
leveraged exposure within liability driven investment (LDI) strategies. The fallout from the fiscal announcement prompted the Bank of England to instigate a short term gilt buying programme to prop up government bond markets which threatened to spiral out of control.

Yields fell back sharply after the Bank of England’s pledge to buy up to £65bn of government debt, finishing the month up by 0.7%. However, some damage had already been done for many schemes resulting from hedges being trimmed or removed prior to the yield falls. Despite this, pension scheme funding levels have remained healthy.

Sterling had largely recovered by the end of the month but continues to be hampered by weak growth prospects for the economy. The Bank of England warned that the UK may already be in recession when it raised the base rate by 0.5% to 2.25% earlier in September. The Consumer Prices Index had crept back into single figures in the 12 months to August, falling 0.2% to 9.9%. However inflation is widely expected to rise again in the winter months when the energy price cap increase comes into effect.

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The US Federal Reserve raised rates by 0.75% for a third time in a row in September but US inflation was down 0.2% to 8.3% over August. The European Central Bank also raised its base rate by 0.75% – a record rise for the ECB. Borrowing costs in Europe are now at their highest level since 2011 as the EU combats rising inflation which was up 0.3% to 10.1% in the 12 months to August.

Energy prices rose again in September after suspicious damage to Nord Stream 1 (the primary gas pipeline from Russia to mainland Europe) was branded as “sabotage” by the European Commission but it stopped short of a direct accusation of Russian involvement. Tensions heightened between the US and Russia in the wake of Russia’s annexation of parts of Ukraine which US President Joe Biden branded as a “fraudulent attempt” to claim Ukrainian territory.

Inflation concerns continued to weigh heavy over September capping off a dismal quarter for most major asset classes. Global equities and high yield bonds managed positive returns after a strong July and August, with unhedged overseas investments benefitting from the depreciation of Sterling, but UK equities and Sterling corporate bonds finished the quarter significantly down. Gilt yields had initially fallen in July but rose seismically over August and September. Inflation expectations rose over the quarter as a whole despite a significant fall and subsequent rise in the last week of September.

The aggregate funding level of UK DB pension schemes was up 8% to 105% on a low risk basis over the quarter despite the period of dramatic volatility in gilt yields culminating in the spike at the end of September.

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Source: XPS DB:UK |

The charts above are based on data from The Pensions Regulator, the PPF 7800 Index and the XPS data pool. The assumptions used in the UK:DB long-term target basis include a discount interest rate of gilt yields plus 0.5%. The assumed asset allocation is 16.9% equities, 20.0% corporate bonds, 6.9% multi-asset, 5.1% property, 3.8% private markets and 47.3% in liability driven investment (LDI) with the LDI overlay providing a 60% hedge on inflation and interest rates.

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To discuss any of the issues covered in this edition, please get in touch with Sian Pringle.

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