U.K. pension funds are dumping assets to meet margin calls as the BOE confirmed it will end emergency bond buying, and the reverberations are being felt everywhere from Sydney to Frankfurt and New York. 

In the US, investment-grade corporate bonds are falling, with average prices of around 86 cents on the dollar compared with 90 cents on Sept. 21. U.K. pension funds have contributed to the selling pressure in recent days, according to one Wall Street trading desk. 

In Europe, leveraged loans bundled into bonds known as collateralized loan obligations have been under pressure. In Australia, investors have been asked to bid on mortgage-backed securities that were being auctioned off. The yield premium on Asian investment-grade dollar notes is at a two-month high and headed for a third day of increase.

U.K. pensions are selling to meet margin calls on derivatives they used to help ensure they could keep paying retirees even if interest rates changed, using a technique called liability-driven investing. The offloading that first began after a spike in gilt yields two weeks ago was renewed this week, when the Bank of England confirmed that it plans to end an emergency bond buying program on Friday. Investors are hoping the central bank will back down. 

“The market simply doesn’t have the confidence, for now, that the LDI crisis won’t return and has increased concerns that other pockets of leverage may cause issues,” Janusz Nelson, head of Western European Investment Grade Corporate Syndicate at Citigroup Inc. said. “Until we see some stability in the rates market, wherever that may come from, investors will continue to be nervous around their holdings.”

END OF INTERVENTION

The Bank of England had hoped its bond-buying support measures would create a bazooka so big that nobody would be in any doubt that they would intervene to quell market turmoil, according to a person with knowledge of the matter. Limits on the buying were increased to allay any concerns that anyone seeking to tap the program this week would have difficulties accessing it, the person said, asking not to be identified as the matter is private.

Then traders grew concerned about the end of BOE intervention. Yields on U.K. government securities tied to inflation, known as linkers, moved out again. Yields on sterling denominated investment-grade corporate bonds ballooned to over 7 per cent for the first time since 2009. Their fears intensified on Tuesday when BOE Governor Andrew Bailey warned that the program will end on Friday. The next day, the central bank made its biggest round of emergency purchases since the intervention began last month. 

But the selling pressure in recent sessions has been spreading to other parts of the world as well. U.K. markets have been in a tailspin since Chancellor of the Exchequer Kwasi Kwarteng presented a package of unfunded fiscal stimulus on Sept. 23. 

“Investors fear further selling from U.K. liability-driven investment managers in response to margin calls, including selling of USD high-grade credit,” JPMorgan Chase & Co. strategist Eric Beinstein wrote Wednesday. “There was some evidence of this selling yesterday.”

That selling was manifest in risk premium movements. On Tuesday, U.S. investment-grade bond spreads widened five basis points, according to Bloomberg index data. But the Markit CDX North American Investment Grade Index, a proxy for credit risk, widened just 1.9 basis point. Similar underperformance of cash bonds happened two weeks ago when the U.K. pension issue first flared up, JPMorgan’s Beinstein wrote. 

Meanwhile, selling by U.K. liability-driven funds “continues to result in a much-higher-than-usual” amount of Australian securitization notes being offered, National Australia Bank analysts including Ken Hanton wrote in a Thursday report.

KEY DATE

If the BOE holds course and ends the buying program on Friday, the next crunch date could be Oct. 31. That’s when Kwarteng will announce his medium-term fiscal strategy and the non-partisan Office for Budget Responsibility will publish an accompanying assessment. The date was brought forward by more than three weeks after City of London figures warned Kwarteng that he couldn’t wait until late November to reassure markets.

The BOE plans to begin actively reversing its quantitative easing program on the same day by selling gilts, potentially adding to frayed nerves.

The end of forward guidance by central banks has roiled market strategies based around buying the dip and selling volatility on the assumption that correlations would continue to be stable as they had been for two decades, said Alberto Gallo, co-founder of hedge fund Andromeda Capital Management. Risk parity strategies and 60-40 portfolios are among those that could be vulnerable, he said.

“What’s happening in the U.K. could lead to further volatility also in the Eurozone market,” said Gallo, who previously ran money for Algebris Investments. “There’s a lot of assets that should not be priced where they are now. We’re just at the beginning.”

Elsewhere in credit markets:

Europe

• Activity in the region’s primary bond market slowed markedly on Thursday, with just one deal due to price ahead of crunch U.S. CPI data later on today. The covered bond deal from Landesbank Berlin AG will push this week’s volume above 26 billion euros.
• Spanish utility Naturgy SA announced an early redemption of one of its hybrid bonds, triggering the notes’ biggest price jump since 2016
• Shares of Italian lender Monte Paschi slumped after it set the terms of its rights offer at a discount to the theoretical ex-rights price

Asia

• Asian issuers in the dollar bond market stayed on the sidelines Thursday as yield premiums widened further ahead of the U.S. inflation print.
• Yield premiums on Asia ex-Japan dollar high-grade notes are on track for their highest level since July, a Bloomberg index shows
• Hawkish monetary policy is making bond issuance costlier than loans, according to data analyzed by Bloomberg. Three-year yields for highly-rated companies overtook the one-year marginal cost of lending rate -- the indicative rate at which banks give loans to companies -- earlier this week

Americas

• EnQuest Plc sold the second U.S. junk-bond in as many days, a rare feat in a primary market hindered by rising interest rates and broader volatility. The London-based oil producer sold a US$305 million 5-year note, which was increased by US$5 million prior to pricing, offering a hefty yield of 12 per cent.
• Three high-grade firms that had looked to sell bonds on Wednesday stood down as inflation data topped estimates. The region hasn’t seen a high-grade corporate deal for a week
• Broader primary market volumes remain meager, yet some deals are getting done despite hawkish central bank rhetoric and credit issues hitting the lower end of the market
• Mitsubishi UFJ Financial Group Inc. plans to accelerate lending to global funds and other institutional investors in the U.S., as it moves to overtake Goldman Sachs Group Inc. this year in loans syndicated in the world’s biggest economy