Stocks opened lower today before staging a mid-morning rally. The Dow and S&P both breached positive territory through noon while the Nasdaq Composite pared back some of its initial losses.
The 10-year Treasury yield almost hit 4.0%, too, before quickly falling. Retreating yields helped fuel the morning rebound as the Bank of England (BoE) uncorked another round of quantitative easing (QE) via bond purchases.
Several weeks ago, the BoE rapidly bought UK government bonds (called Gilts) to halt a Gilt “death spiral” that threatened to vaporize thousands of British pension funds. UK bankers revealed in a report to the Financial Times that the world was likely within a few hours of another global financial meltdown had the BoE not stepped in.
The BoE insisted that its bond-buying program (to the tune of about £5 billion worth per day) would end this coming Friday. But instead of shrinking the program, the BoE announced this morning that it would instead widen the scope of its bond purchases.
The bank said it would “temporarily absorb selling of index-linked gilts in excess of market intermediation capacity,” which means that it will start buying index-linked gilts. The BoE is doing so in response to yesterday’s wicked gilt selloff that happened despite the recent QE reboot.
Now, the bank is set to purchase £5 billion in conventional gilts (what it was already buying) plus an additional £5 billion worth of index-linked gilts per day for a total of £10 billion in gilts. It makes sense, too, given that these index-linked (aka, inflation-linked) gilts were to blame for the gilt meltdown in late September.
Both types of gilts – conventional and inflation-linked – endured heavy selling yesterday.
“The beginning of this week has seen a further significant repricing of UK government debt, particularly index-linked gilts,” said the BoE in a statement this morning.
“Dysfunction in this market, and the prospect of self-reinforcing ‘fire sale’ dynamics pose a material risk to UK financial stability.”
The UK’s financial structure could easily collapse if the BoE stops buying gilts. This has essentially trapped the bank in a perpetual cycle of QE amid sky-high inflation.
But don’t worry, the BoE will continue to hike rates despite ramping up QE. That’s like applying pressure to the brakes and stomping on the gas at the same time in the hopes that your car doesn’t drive off a cliff.
Analysts recognized that and lambasted the BoE in morning notes.
“The fact the Bank of England has widened its support measures for the market by including index-linked gilts in its program of government bond purchases will only serve to worry investors even more,” said AJ Bell investment director Russ Mould.
But what happens when Monday hits? Will the BoE keep buying bonds?
“The key sticking point is that the support measures are only scheduled to last until Friday,” Mould said. “Will that be long enough, or will the Bank of England extend the support scheme? Extending it could go one of two ways — the market either applauds the move and breathes a sigh of relief or it gets even more worried, thinking that the extra time suggests the crisis is more severe than originally thought.”
Yesterday’s gilt selloff indicates that investors are starting to sense real danger now. Continued QE may only worry markets further, even if it’s a better short-term move than halting QE completely.
That’s why bulls need to remain very careful this week if the September Consumer Price Index (releasing Thursday morning) comes in cooler than expected and sparks a rally, as Monday could provide another “market-breaking” moment regardless of what the BoE decides to do.
