This morning I took a very short break from my current pastime of crushing on Mark Carney to check on the yields of UK gilts after yesterdays QE auction. The thought had crossed my mind at the weekend- ‘what if no one wants to sell?’ So I thought Id have a quick look at them to see how its all going.
I don’t think were going to be seeing that devastatingly beautiful smile any time soon.
This week Ive been thinking about just how much revision and re studying I have to do before I can make any decent meaningful analysis ( because I did my degree a while back but am now getting back into it in a big way ), hence the slowdown in blog posts. I really want to know what Im talking about before I jump in and start going on about things and then come to a totally wrong conclusion. As Sherlock Holmes says, ‘I cant form a theory with no facts!!. ‘
So I thought Id leave it a while before I aired my views on QE and low interest rates and how I feel it may ultimately lead to more instability in the financial system. Because unlike those amazingly clever (not to mention sexy-well one of them anyway) and talented people at the BoE, I don’t have my own formal model that maps out exactly how the economy will react when you do something like QE to it. (Yet. One day I will have a model oh yes!)
So surely they know way more about it than me. Of course they do. As an inexperienced graduate getting to grips with applying theory to the real world, its easy to fall prey to the fear of getting it wrong.
So its quite comforting to see that even the experts get taken completely by surprise sometimes. I guess they just didn’t see it coming. That in times of uncertainty, gilts are the one thing that people wont want to get rid of. Hardly rocket science when you think about it. Bonds will always pay you x amount unless youre in a really dodgy country that reneges on its agreements. Yes, those returns will be lower than other, more exciting and risky investments, but in times of uncertainty people want boring and predictable. Wouldnt you? Especially if youre a pension fund that uses that income stream to pay out to your current customers.
Yesterday the Bank planned (hoped) to buy £1,170mn of long term government bonds from non banking institutions using ‘printed’ money (although they like to call it ‘central bank reserves’.)
These institutions are then supposed to take this money and spend it on more risky assets, thus increasing investment and getting all that new money out there. Plus, in the process of yelling, ‘PLEASE SELL US YOUR BONDS FOR GODS SAKE!!’ the increasing desperation of the Bank to buy them pushes up their price as the Bank makes higher and higher offers, thus lowering the actual yields- which is then reflected in a lower cost of borrowing-Hooray! So its effectively another way to reduce interest rates, except its more indirect than the official Bank rate, over which they have full control.
But yesterday, only 2 days into a 6 month programme of QE, for the first time since its inception, they could not find enough sellers and missed their target. (Albeit only by 4%-so perhaps this isnt the huge disaster everyone is making it out to be. The BBC tends to overdo it a bit at times!)
And I think that’s the reason why I love economics so much-it never plays by the rules. As soon as we make them up, those rebellious, troublemaking markets break them.
Sometimes, the more you try to fix something the worse it gets. Kind of like that woman who tried to restore the picture of Jesus ( I cant resist posting the link because it is truly a catastrophe of epic proportions! )
Worst. Restoration. Ever. Elderly Woman Botches Touch-Up Job on 19th Century Church Fresco
Mark Carney has stated previously that he is not a fan of negative interest rates but oops, the gross return yield (regular yield plus any gains made from buying it at a lower price than its face value) were negative on a handful of short(ish) UK gilts this morning.
Perhaps this shows what an impotent corner the Bank is now backed into. The interest rate cut is so low that the Bank has to lend money to banks longer term (the official Bank rate is only for overnight loans) so they can pass the cut on to customers. (As if! Have I had a letter from my mortgage provider yet? Noooo!). In other words, the rate cut alone simply isnt enough. And now QE isnt even working!
Perhaps the bank should think about buying things that people actually want to sell. Makes you wonder what the next incarnation of QE will be-Helicopter money? (where the government or banks are basically given new money in exchange for newly created bonds, as opposed to existing ones like in regular QE.) The bank investing in other assets like real estate? Or maybe they should just use their central bank reserves to buy stuff from Ebay. £70 billion worth! Wont change interest rates on bonds but it would get the money out there! (UK based sellers only though of course because we want all that money to stay in the UK!)
But perhaps yesterday was just a weird quirk-in todays auction of medium term bonds they were all too keen to get their hands on Mr Carneys stimulus package, having nearly 5 times as much offered as they needed. Mondays auction was also presumably a success, given that no one mentioned any epic failures on Monday.
So that leaves me with the question- why are people quite happy to sell their short to medium bonds, but not their long term ones, and why didn’t the Bank see it coming?
Unfortunately I will have to wait until I get to the chapter on bonds to find the answer to the first question (although I think I already have a pretty good idea.)* The second, Ill leave in the capable ( and slightly glittery) hands of the oh so lovely Mr Carney.
Until next time (whenever that may be)
*OK so I think its this: if youre a pension fund you know youre always going to have liabilities i.e. money you have to pay out. If you have a bond that isnt going to mature until a new species has actually evolved, then that’s a very nice, safe, long term income stream that you will want to hang on to. Now if you have shorter term ones, sooner rather than later they are going to mature and you will have to replace them with new income streams, probably more bonds. But you wont know how much you’re going to have to fork out for these new cash cows until you go to market to get some. So this may lower you profit levels overall. Plus, if someone like the Bank of England is willing to pay a high price for them, you can make a nice profit if you bought them for a lower price.If I had a choice between a guaranteed income that Id already paid for and having to go out and buy one, I know which Id prefer.
What now??! 