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• QT Tantrum – Bank of England u-turn to buy gilts shows its aim of £80billion gilt sales is unrealistic and likely to be far worse than 2013 US taper tantrum.
  
• Bank of England had to step in as UK pension fund margin calls – on top of international investor selling – meant there were no buyers.
  
• The QE experiment has left a dangerous legacy across the Western world, but the UK has suffered most due to collapsing international confidence about rising debt and weaker growth.
  
• The sudden collapse in confidence in UK Government debt and currency requires a rethink of policy decisions that no longer fit the environment. 

Today’s extraordinary intervention by the Bank of England in the UK Government bond market is a clear u-turn. Just a few days ago, it was actually planning to start selling £80billion worth of gilts, as the first step in trying to unwind the hundreds of billions of pounds of bond purchases from QE (Quantitative Easing). The announcement today, although saying that the gilt-buying would only be temporary, is a further indication that it will be well-nigh impossible to actually unwind QE without crashing the markets and creating further pressure on Government debt levels.

QE cannot be unwound without a crash: It was never realistic to expect such huge amounts of assets to be sold back to the markets. Of course it should have been clear that gilt yields would need to rise to get back to some kind of normality, but the extreme economic shocks that have hit the global economy since 2008 have been controlled by central bank actions and policymakers have relied on QE to facilitate their other policies. The financial crisis, caused by excess borrowing and irresponsible lending, was mitigated to avoid meltdown by the initial creation of money – what used to be called ‘money-printing’ but was given a fancy name of Quantitative Easing.

Central banks kept saying this would be temporary, but it carried on and 2013 ‘Taper tantrum’ showed Fed could not cut back: In 2009, QE was meant to be a short-term experiment to avert deflation and economic collapse.  However, even when inflation rose and economic activity stabilised, the measures were not unwound. Markets and politicians benefited enormously from the massive amounts of new money created by central banks, that could prop up asset prices and fiscal projects. When, in 2013, the US Federal Reserve said it was planning to taper its bond-buying, the bond markets rebelled in the so-called ‘taper tantrum’, causing sharp market sell-offs and the Fed had to halt its plans.

Recent gilt yield spikes were a ‘QT tantrum’ as markets stage a buyers’ strike: What we have seen in the UK in the last few days is an echo of the taper tantrum, as a ‘QT (Quantitative Tightening) tantrum’. The markets rebelled just ahead of the start of the planned sale of £80billion of its bond holdings by the Bank of England.

Until sterling’s collapse, the gilt yield rises were containable: Gilt yields have been rising for several months already – for example 30 year gilts yielded under 1% at the end of 2021, but by July the yield had risen to 2.5%, and in August to 3%, which entailed significant capital losses for gilt-holders. However, other global interest rates were also rising, so the UK did not stand out as so exceptional. With inflation and interest rates increasing across the world, the rise in gilt yields did not create undue concerns.

Collapse in confidence since last Friday sent the market into freefall, as international investors kept selling: Since last Friday, however, international investors have focussed specifically on the UK.  The loss of confidence in Sterling following Friday’s fiscal event, led to a rushed exit from UK assets, which has accelerated the rise in UK gilt yields, which spiked to 4% in the past few days and this morning crashed through 5% as the Bank of England stepped in to try to stop the vicious spiral.

UK pension funds were caught with collateral calls, making them forced sellers too: One of the major problems for the markets was that some UK pension funds, which have hundreds of billions of pounds invested in bonds, had to sell their gilts or other assets, to meet margin calls on their gilt derivative contracts. Although they have been required to meet such collateral demands in recent months, as gilt yields have risen sharply, they were mostly able to manage to those, because in the past few years, they have received cash on these contracts, as gilt yields kept falling after successive rounds of QE.  But the latest spike was too much for many of the funds to manage, or had exceeded the buffers which they were holding. In addition, the financial firms who had issued the derivative contracts, were demanding that cash must be paid within one or two days, whereas in the past it could be one or two weeks, to allow time for a more orderly process.  If the pension funds could not raise so much cash – and it is reported that a typical £1billion pension fund may have faced a sudden cash call of over £100million – they became forced sellers of gilts or other assets, adding to the pressure from international sellers.

The situation in the markets was spinning out of control:  There seemed to be no investors willing or able to step in to buy gilts, because of the fears that rates would keep rising as the rout gathered pace.  That is why the Bank of England, given its remit to protect financial stability, stepped in to buy.  It succeeded in bringing 30 year gilt yields down to around 4% through the day. Pension funds can benefit if gilt yields rise slowly, because the present value of their liabilities is lowered and they can expect to earn higher returns over time to meet their pension payments, but the speed of the increases resulted in a situation that could have spun out of control and the Bank of England has bought some time for other measures to be considered.

After many years of QE making policy decisions much easier, Government now needs to make hard choices: Public and private debt are at very high levels, as they are in many other countries, especially after the Covid and energy price interventions and the Balance of Payments deterioration since leaving the EU.  Markets need to have confidence that the UK has a plan for reducing the debt, boosting growth and managing inflation over time. Government must recognise the importance of restoring confidence in UK economic management urgently, if we are to avoid an ongoing series of crises.