BOE Can’t Part Investors From Long Bonds as QE Hits Snag

Why Low Rates Are Making Long-Term Investors Struggle
  • Second operation of expanded buying fails to reach target
  • Longer bonds ‘a really difficult area’: Aberdeen’s Hickmore

The Bank of England’s expanded quantitative-easing program ran into a stumbling block on just its second day as investors proved unwilling to part with their holdings of longer-dated bonds.

The central bank failed to buy enough gilts to reach its stated goal at an operation on Tuesday -- the first such failure since it initially started quantitative easing in 2009. The yield on 10- and 30-year bonds fell to records after the operation. The BOE, led by Governor Mark Carney, said on Wednesday that it will incorporate the 52 million-pound shortfall into the second half of the six-month program.

“Lots of people are bidding us for bonds -- Mark Carney is now bidding me for bonds and he still can’t have them,” Luke Hickmore, an Edinburgh-based senior investment manager at Aberdeen Asset Management Plc, which oversees about $400 billion, said in a Bloomberg Television interview. “The problem is he was trying to buy 15-year plus bonds today in the gilt market. That’s a really difficult area.”

The BOE is expanding its gilt holdings as part of suite of measures announced last week to contain the fallout from the U.K.’s decision to exit the European Union. The stimulus, which included the first interest-rate cut in more than seven years, will see the central bank increase its holdings by 60 billion pounds ($78 billion) to 435 billion pounds over the next six months.

Uncovered Operation

The BOE’s failure to reach its target on Tuesday is an early warning of the challenges it may face in expanding its QE plan. The central bank already scooped up about a third of the U.K. government bond market as part of a program that started in March 2009.

“You’d understand why investors might not be keen to offload longer bonds -- if you are looking for yields that’s the only place on the curve to be,” said Jason Simpson, a London-based fixed-income strategist at Societe Generale SA. “It is a bit of a surprise that this went uncovered in the first week of the operation, goodness knows what happens next week.”

Accepted All

The central bank said it received offers to sell 1.118 billion pounds of gilts due in more than 15 years on Tuesday, compared with a target of 1.17 billion pounds. The scarcity led to the BOE accepting all submissions, even as some investors offered prices above the prevailing market. The highest accepted price for the 4 percent bond due in 2060, for example, was 194.00, compared with a weighted average of 192.152.

For a closer look at the prices paid by the BOE, click here.

Since the BOE paused purchases in 2012, global bond yields have tumbled, meaning investors may be less willing to part with longer-term bonds that tend to offer higher yields than their shorter-dated equivalents. Long-dated U.K. bonds are in particular demand from pension companies that hold the securities to match their liabilities.

Hunting Yield

Longer-dated bonds are “an area where people are hunting down what yield is left -- you have to extend out into that area to get anything really,” Aberdeen’s Hickmore said. Carney “is going to say ‘it’s very early days, this is day one of the long-end purchasing.’”

To see the full interview with Hickmore, click here.

In the first round of buying on Monday, investors offered to sell 3.63 times the 1.17 billion pounds of gilts due between three and seven years that the BOE was seeking. Another operation, for the seven- to fifteen-year sector, is scheduled to take place on Wednesday.

The BOE has said it will purchase securities evenly across three maturity sectors, with the size of auctions kept under review throughout the program to respond to market conditions.

“Yesterday we saw a 3.63 cover in the short APF so this is a sharp difference that has really caught the market off guard,” Daniela Russell, a portfolio construction associate at Legal & General Group Plc in London, said on Tuesday. “Yields are edging lower and the gilt curve is flattening, with long-dated bonds outperforming.”

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