DM Rates: BOE provides a circuit breaker
The rout across assets took a breather overnight as the Bank of England pledged to buy unlimited amounts of long-dated Gilts to calm the market. This operation is set to take place until 14 October. Meanwhile, Gilt sales are now delayed till end October. Financial conditions got dire over the last few days (comparable or slightly worse than June) as market participants lost confidence in GBP assets. To put things into perspective, 10Y Gilt yields more than doubled from the low in August to briefly poke above 4.5% overnight. Post BOE’s announcement, 10Y yields eventually settled closer to 4%. Amid these swings, DM yields got dragged along with 10Y UST yields also briefly topping 4%. Combined with swings in the GBP, things looked particularly dire in the investment landscape.
The BOE clearly bought some time. However, it is not clear how long this calm would last. The current unlimited bond buying likely mean that long-dated Gilt yields are capped. However, there are consequences to running what looks very similar to quantitative easing. The creation of reserves typically come with a side effect of a weaker currency. This is perhaps most clearly illustrated with the BOJ’s YCC. By capping 10Y yields at 0.25% when DM yields are rising, the JPY has to take the hit. Accordingly, the market moves overnight feels more like an adjustment of positions as investors were caught in the same direction and forced to cover. Note that nothing has fundamentally changed other than a circuit breaker (provided by BOE) has taken place. The pressure for the BOE to hike aggressively and perhaps inter-meeting is still there. We also do not think that the current market volatility / economic conditions would derail further aggressive Fed and ECB hikes. Opportunistically, DM rates / yields no longer look prohibitively high.
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