Following major sell-offs across bond markets, new figures revealed that the U.K. bond market has shed more than £1.3 trillion ($1.4 trillion) since the beginning of 2022.
Just over £882 billion ($1.02 trillion) has been wiped off the value of Gilts and Index-linked Gilts in the year-to-date. The value of the U.K. corporate bonds has also fallen by £514.5 billion ($594 billion) since the beginning of the year.
"The unprecedented meltdown in bonds is not just causing issues for pension funds with exposure to liability-driven investment strategies. The fall is also wrecking the returns for any investor with large exposure to U.K. bonds," said Colin Leggett, investment director at Collidr.
"Few individual fund managers have actually experienced a fall in the bond markets on this scale," he added. According to Leggett, many fund managers are now suffering in this unprecedented unwind of U.K. bond positions. Some may have been caught off guard by the speed and aggressiveness of the sell-off, while others may have been slow to slash the allocation to longer duration bonds.
The Bank of England (BOE) bought bonds in financial markets to push the interest rates near zero, in hopes that easier money would give investors confidence and help foster growth. Its move sought to reverse the quantitative easing (QE) program that helped prop up the economy through the global financial crisis and the pandemic. (Related: IMF: Russia-Ukraine war may FUNDAMENTALLY ALTER economic, political order worldwide.)
While the QE kept a lid on its market interest rates, Governor Andrew Bailey hopes that its reverse – quantitative tightening (QT)– can run in the background and leave the focus on the BOE's benchmark lending rate as the main tool for managing monetary policy, and it has been working so far.
Gilts extended gains later as traders pared their bets on future rate hikes and pricing interest rates to peak above 4.75 percent next year. Meanwhile, the U.K. five-year yields traded at 3.48 percent, going down 13 basis points.
Pooja Kumra, rates strategist at Toronto-Dominion Bank, said the sales do not appear to experience many hiccups with short-maturity bonds holding up well against their long-end peers.
BOE pares back government bond holdings
The BOE started paring back its government bond holdings in February, when it agreed to allow maturing debt to roll off the balance sheet instead of replacing them. While the Federal Reserve – its American counterpart – is doing the same, it still hasn't pursued active sales.
This experiment came at a delicate moment for the Treasury and BOE. Once the planned sales are added up to the government's financing needs, investors will absorb the largest supply of U.K. bonds in history, as per their debt chief.
"The risk that the BOE faces is that QT is beginning at a time when there is going to be an increase in supply given the fiscal measures that have been announced," said Imogen Bachra, head of UK rates strategy at NatWest Markets.
The BOE's £750 million ($866.03 million) sales on Nov. 1 will also wipe a larger amount off its balance sheet due to the difference between the nominal value of the bonds and the price at which the BOE sold them.
Selling them at a lower price also crystallized losses for the government, which is the one financially responsible for the portfolio.
The BOE is hoping to reduce its holdings by £80 billion ($92.38 billion) in the next year and will include around £35 billion ($40.41 billion) of redemptions, leaving around £45 billion ($51.96 billion) of reduction from sales.
The government's decision to actively sell its gilt holdings contrasts with the European Central Bank's approach, which was widely expected to have been done on a passive basis, and was not expected to begin until 2023 at the earliest to avoid roiling fragile markets.
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