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Bank of England Bail-Out, the Return of Systemic Risk

Bank of England Bail-Out, the Return of Systemic Risk

The BOE move was cheered by bond and stock markets alike, but risk appetite is retreating again this morning…

Good morning contrarians! It is Thursday, Sept. 29.

Stocks rallied yesterday after the Bank of England said it would intervene in bond markets. The central bank will buy £65 billion worth of long-dated gilts at an “urgent pace” and postpone plans for quantitative tightening. The Wall Street Journal has a good piece that gets into the quandary the BOE was in. Apparently pensions were on the hook for holding derivatives tied to interest rates.

Whatever the cause, the result was major relief in bond markets, which then spread to stocks. Twenty-nine of 30 Dow stocks finished the day higher (the one exception was Apple (AAPL 0.00%↑)) and the Dow Industrials Average escaped bear market territory with a rally of almost 2%. The gains were most dramatic in small caps, with the Russell 2000 gaining 3% on the day.

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State of Play

As of 0620 it looks like risk appetite has receded again:

  • Stock futures are pointing to losses at the open, with the Nasdaq down 1.3% and S&P 500 down 1%;

  • Selling has returned to the bond market as well, with the 2-year yield up 12 basis points to 4.21% whilst the 10-year is up 13bps to 3.84% (yields move inversely to prices);

  • Cryptos are gaining ground however, with Bitcoin up 4% to trade around $19,400;

  • Commodities are moving a bit higher, with WTI crude oil up 0.5% to trade around $82.50/barrel. Copper is up 1.4%.


It’s a pretty big day for earnings, with Bed Bath & Beyond (BBBY 0.00%↑), Rite Aid (RAD 0.00%↑), and CarMax (KMX 0.00%↑) all reporting before the open at 0930. Later we’ll hear from Micron (MU 0.00%↑) and Nike (NKE 0.00%↑).


It’s Thursday so we’ll get initial jobless claims at 0830. Economists surveyed expect 215,000 new claims, roughly in line with last week’s 213,000 and nowhere near the level that would indicate a slowing labor market.

We also have another GDP report that can be safely ignored. If people can’t decide whether GDP prints define recessions then there really isn’t any point to pay attention anyway. It’s just another revision anyway.

Cleveland Fed President Loretta Mester speaks at an event on inflation at 1300 that will apparently be broadcast live.

The Bottom Line©

The BOE move was cheered by markets but it does raise questions. If pensions are behaving like hedge funds by betting large amounts of money on esoteric (and illiquid) interest rate swaps, then that would certainly introduce a level of systemic risk to the system.

If all that sounds familiar, it’s because it’s exactly what almost brought down the whole financial system in 2008. Except then it was banks trading these things, not pensions. (Okay, strictly speaking they were different instruments. But whatever, they were still derivatives). They say regulators are always guilty of fighting the last war. Well, bank balance sheets are pretty clean these days. But pensions? Does anybody know what they’re even holding? And who are the counterparties?

The derivatives in question appear to be liability-driven investments, or LDIs. The size of this market? About $1.5 trillion (not a typo). This raises the very obvious question of what other pension funds in what parts of the world are trading these things.

We’ve cautioned for some time that once the whole market starts rolling over it could unearth problems that nobody had been anticipating. This is typical of market shifts of this size. Well here we go. So nice little bounce yesterday. But it would be pretty naive to think this issue is resolved and we can live happily ever after.

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