AroundTown: bad call (again)
Traditionally, monetary policy tightening takes the form of hiking interest rates, a concept very familiar to market participants. However, after more than 10 years of quantitative easing (QE) ballooning central bank balance sheets, central bankers have a new tightening tool known as quantitative tightening (QT) – the active selling of central bank assets. With even the most seasoned market participants lacking experience of this phenomenon, its impact remains an unknown for the market.
In February last year, the Bank of England was the first to announce its QT programme, which would begin with corporate bonds rather than its government bond holdings. The initial announcement drew plenty of attention, but it lacked detail and surprised investors , sending credit spreads 10-30bp wider. Ultimately no one really knew how to quantify the impact of this new tightening tool. How many 25bp interest rate hikes is the sale of £20bn of corporate bonds worth? Would there be any impact at all?
With the last 12 months being such a challenging period for the sterling bond markets for a host of reasons, it is a good time to check in on the progress of the BoE’s QT programme.
To recap, the BoE’s corporate bond portfolio was initially suspected to total around £20bn, with active sales beginning in Q2 2022 and with a target end date of Q1 2024. Market weakness and volatility led to a delayed start date, with auctions finally beginning in August, at which point the size of the portfolio was disclosed as £14.5bn, much less than initially expected. Given the target end date, this meant on average £200-300m of weekly sales, an amount which many believed was manageable.
After 10 weeks of active sales the BoE’s remaining balance is £9.75bn – an above-target weekly run rate of around £460m – while a number of tenders and maturities have also helped reduce the portfolio without active selling.
So far the market impact of QT in terms of pricing has been negligible, with several technical factors helping the market to digest the assets. Front loading of issuance through 2020 and 2021 has resulted in limited supply needs for sterling issuers both last year and this year, while the unfavourable QT backdrop has sent certain would-be sterling issuers to other currencies. The UK’s National Grid is a prime example; last year it didn’t issue a single sterling deal, instead opting for euros despite having no euro assets or any operational need for the currency.
Ultimately, the BoE’s assets have been a welcome substitute for investors in a market starved of new supply. Given where yields are, paired with the uncertain macro backdrop, there is plenty of demand for just the sort of high quality duration assets the BoE is selling, especially from pension funds.
All things considered, so far QT appears to be a success. The market wasn’t expecting these assets to be so seamlessly absorbed, and in a market starved of supply the BoE has served as a welcomed source of offer-side liquidity. With approximately one-third of the portfolio gone, the BoE is on track to finish well ahead of schedule should this pace be sustained. Auctions are due to restart on Tuesday after a hiatus over the Christmas break, but given the strength we are seeing in primary markets, it will be business as usual for the BoE.
Of course, in terms of QT’s tightening effect looking at corporate bonds alone does not paint the full picture. The real test will be how well the market digests the active sale of larger volumes of government bonds from central banks, which will vary by market with different technicals at play.
We don’t yet have enough data to evaluate this given the BoE has sold less than £50bn of its £875bn Gilt portfolio, the Fed has only halted reinvestments on its $5tr-plus portfolio of US Treasuries and the ECB will be taking a similar approach to the Fed beginning in March. Ultimately, we may never be able to quantify Xbn of QT or QE in terms of interest rate hikes or cuts, but this opening salvo of QT from the BoE might give central bankers some confidence for the much greater challenge ahead.