The big market-moving news this week – as you probably know by now – was the solvency problem in the leveraged UK pension funds. (Leveraged? Pension funds???) The UK pension funds were holding UK sovereign debt, the price of which has been plunging (due to rising rates), which wouldn’t normally matter (just hold until maturity, and all is well), unless, of course, they were using a ton of borrowed money to amplify the yield on the bonds. Which, it turns out, is what they were doing.
Why borrow money? Turns out the rates on government bonds were too low for the pension funds to meet their obligations (thanks central bankers), so the pension funds ended up taking much larger risks, using leverage. And using leverage to create a large portfolio of government bonds worked great, right up until the moment the rates on these bonds started to rise rapidly. And then – suddenly – it wasn’t fine anymore. There were (probably) margin calls; bankruptcy beckoned.
So, to head off this impending leveraged-pension-fund destruction, which would most likely have angered (and impoverished) a large number of pensioners, the Bank of England stepped in to buy the plunging (probably no-bid) government bonds in question. “We’ll take all of them.” Whew. Leveraged-pension-funds saved from destruction. At least for the moment. That was Wednesday. And all it cost was 65 billion pounds.
Bank of England to buy 65 billion pounds of UK bonds to stem rout (Source – Reuters).
BOE Ignites Global Rally in Everything From Stocks to Bonds (Source – Bloomberg).
Initially, this move was seen as a pivot signal by the enthusiastic herd in the risk asset markets; equities, crappy debt, etc, which rallied strongly on the news. “Yay the pivot has arrived! We’re back to central bank buying sprees!”
The optimism lasted a day. Unfortunately, equities then sold off some more, ending the week at a new low. So the leveraged UK pension funds were (temporarily) rescued, but equities and crappy debt both continued downhill.
Regardless of whether the long hoped-for pivot is in our near-term future, all this is a really big deal. It reflects a serious solvency problem in pension funds in Europe, and perhaps in the U.S. also. That’s why I’m going on about it – this event is a signal of things to come.
by davefairtex 
