GBP Swaps: Market adapting to BOE approach; LDI’s loss…

BOE Front 22 Jun 2020
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The new government’s salad days continue to yield unexpected fruit. In the gilt market it was linkers turn to for volatility. Is LDI over?

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  • Market adapting to BOE approach?

  • LDI’s loss is insurers' gain?

     

    Market adapting to BOE approach?

    The new government’s salad days continue to yield wholly unexpected fruit. Today’s headlines see the first proper post-mini-Budget estate agent property forecast predicting a 10% drop in house prices over two years as average 5y mortgage rates breach 6% for the first time in ten years. The LDI sector faces a shrunken future and the gilt market faces a cliff-edge on Oct 14 when BOE support for the market is scheduled to be withdrawn.

     

    So all good. Today the market was pretty quick to get into bear-steepening mode, with most of the main moves completed two hours or so before the BOE predictably failed to make significant purchases in the latest, and accurate prediction that led itself to gilt curve steepening.

     

    And steepen it partly did. While the ranges were pretty wide again (24bps in 10y), it was generally less wild and after a brief selloff after the BOE reverse auction results - the BOE bought £155m and rejected £127m - 30y yield ended the session +10bps but off the highs and outperforming 20y and 50y.

     

    With USTs also under pressure at times the gilt future lost 1.9 points in 195K, the lowest volume since mid-September. 

     

    In swap spreads the 5y ended the day 6bps richer, 10y was +3bps leaving only 30y to hint at the madness at the heart of this market with a 9bps leap.   

     

    In linkerland, real yields sold off strongly through the morning session, drifted lower through lunchtime and then fell strongly into the close, taking back some of yesterday's big rise. Long linker yields fell by 10-15bps and breakevens widened by 20-30bps, versus 10-20bps for RPI swaps.    

     

    One (still busy) swapper said this evening in London that “yeah, it was a little bit calmer today, gilts sold off and tried to come back a little bit. Ranges were down. But the big problem with gilts that I haven’t worked out is what’s going to happen on October 14 (‘QE’ withdrawal), and what’s going to happen after that,” with QT scheduled still scheduled to start on October 31. For more on the BOE's thinking, and the reasons for its intervention last week, see Total Derivatives.

     

     

    LDI’s loss is insurers' gain?

    The sudden need for pension funds to put up large amounts of extra collateral due to tumbling gilt prices will lead more UK defined-benefit pension funds to favour pension risk transfer deals with life insurers over LDI arrangements with asset managers, Fitch Ratings says today.

     

    Fitch, which earlier affirmed its AA-minus rating of the UK, but with a negative, rather than stable, outlook, said “we believe pension schemes’ appetite for LDI solutions will be greatly reduced as a result.”

     

    With LDI funds falling out of favour, Fitch said it “expects pension schemes to become more interested in pension buy-in and buy-out deals with life insurers. It contended that “pension de-risking through insurers involve less risk than LDI funds. Pension funds or pensioners are still exposed to the risk of insurance companies failing, but insurers are subject to substantial capital requirements, including a requirement to match long-duration cashflows with suitable assets.

     

    Fitch forecasts “significant growth in pension risk transfers, and rising bond yields will support this as they will improve pension scheme funding levels and make deals more affordable.”

     

    Consultants at LCP were also positive about the buy-out market, despite doubts about capacity after £12bn of deals in H1 2022, up 50% on 2021. "Many of the insurers already have an extensive pipeline of new business with limited capacity to take on more quotations,"  LCP warned. Still, "if markets stabilise at current levels then many pension schemes may find themselves sitting on big funding improvements compared to even a month ago.  This could lead to a bonanza for de-risking markets next year as schemes seek to lock in the good news through buy-ins and full buy-outs and potentially some of the emerging solutions such as superfunds."