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LONDON: The United Kingdom’s pension sector created the modern gilt market.
Last week, it almost broke it.
For decades these investors have demanded long-dated assets to match their liabilities going out decades into the future, particularly for defined-benefit programmes which need to make payouts irrespective of market moves.
That’s been a boon to UK government finances, with the average maturity of the nation’s debt outstripping its peers.
But last week, that symbiotic relationship started to unravel. The market saw new Prime Minister Liz Truss’ unfunded tax-cut policy as fiscally reckless.
Pensions which pursued so-called liability-driven investment (LDI) strategies with leverage faced emergency collateral calls on their hedges as government bond yields soared, resulting in the largest selloff in history.
The Bank of England (BoE), which had been on a mission to reduce its balance sheet, was forced to start buying bonds again to calm the turmoil, sparking the greatest rally on record.
For investors whiplashed by this unprecedented volatility, the risk is the worst isn’t over.,
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There’s no sign yet of a Truss u-turn ahead of a Conservative party conference this week, even with the pound having slumped briefly to a 37-year low.
And for some, the long-lingering fragilities in the market remain exposed to another blowup.
“The challenge for the BoE is to ensure there are sufficient tools in place to maintain market functioning,” said Daniela Russell, head of UK rates strategy at HSBC, who predicted the need for an intervention last week.
“It needs to recognise that the pressures on pension schemes have not suddenly disappeared.”
Pension fund demand for long-dated bonds and inflation-linked paper has been near-insatiable since the so-called minimum funding requirement came into force in 1997.
The rules, which set valuation metrics to ensure a minimum level of solvency, have been followed by updates that have meant the appeal of such securities to the UK pension community remains high.
“It’s what makes gilts unique among global bond markets,” said David Parkinson, sterling rates product manager at RBC Capital Markets. “UK debt has a much longer average maturity than anywhere else because of that pension demand.”
Yet last week demand for long bonds collapsed.
The yield on 30-year inflation-linked gilts – favoured by these pension funds due to its long maturity and its protection against price increases – soared 76 basis points last Tuesday, a fresh record which eclipsed a 68-basis-point spike a day earlier.,