While Bailey is attempting to calm the markets by telling everyone that inflation is only temporary for a year he is also attempting to scare everyone.
In his initial warning he stated that “market volatility went beyond bank stress tests ” which means that those nice stress tests where they say if this bad thing happens and that bad thing happens can the banks withstand the stress and come out on top until something real happens?
He has already stated that banks cannot withstand market volatility and that there is a serious risk to the stability of the UK financial system despite the fact that the buying program is only temporary. This is what spooked the market the most.
His message to all the funds and firms involved was that they only had three days to sell and that they should:
“You’ve got to get this done. The essence of financial stability is that it (intervention) is temporary. It’s not prolonged.” Paraphrasing this it means that this not only refers to the pension funds.
To halt this massive rise in interest rates the Bank of England intervened lowering them to around 3.6% but they have since crept back up and they have also added inflation-linked debt to their purchase program.
However it appears that traders are hesitant to offload large quantities of guilts which are UK bonds due to the Bank of England’s approach to purchasing.
So basically the Central Bank only brought these bonds that were close to the current market level and rejected offers that it deemed too expensive implying that they will not buy bonds at any price but at a price that is very close to where the market is trading so that they are not attempting to bail out the price that these investors paid for these bonds by overpaying what the current market is.
Investors may receive a slightly higher price if they sell their bonds to the central bank rather than the open market but the difference is measured in fractions of a percentage point.
So they basically have to put in these offers that are very close to where the market is trading and hope that the Bank of England accepts them and while they wait to hear back about the offer the actual market could be moving against them in the meantime.
This is distinct from the QE programs implemented following the financial crisis the Brexit vote and the covid outbreak. They had previously purchased a predetermined amount of bonds at any price with the intention of lowering yields.
So they stated that they have no intention of seeking lower bond yields and that the Pension Funds would rather sell riskier assets such as corporate bonds or real estate. When things are bad people usually sell the riskiest items first and keep the safer items.
With these comments the FED terminal rate expectations meaning how high they think interest rates are going to get in this raising cycle fell a little bit as well as the subsequent rate cut expectations that they expect for next year also fell a bit. And the dollar which fell earlier in the day rallied almost back up to the previous highs after Bailey’s comments.
As a result the British pound fell from around 111 and a half to just under 110. When Bailey made that statement SP Futures the Dow the Russell and the Nasdaq all fell. The 10-year notes followed suit reaching 4% causing yields to fall. Essentially the drop in yields following his comments is due to investors buying ten-year US Treasury notes as a flight to safety from what’s going on in the UK and elsewhere.