Skip to content

Open Market Operations

OMO. Something the Bank of England has an entire department doing. All the time.

Britain’s pension funds were on Wednesday at the centre of the financial crisis sparked by the mini-budget forcing the Bank of England to launch a £65 billion emergency bailout.

The Bank warned of a “material risk to UK financial stability” and stepped in to buy long-term gilts, as plunging markets for UK debt sent borrowing costs spiralling and forced pension funds to dump their assets. Economists compared the crisis to the run of withdrawals that led to the collapse of Northern Rock in the financial crisis.

As Andrew Again explained so very well in the comments to this thread. Given that this is in fact his own bread and butter, daily work, we should be taking his description as having at least some validity.

Pensions funds own lots of gilts because Gordon Brown forced them to. There’s not much return on gilts (return after inflation has been negative for a long time, not what you want in a pension fund “investment”) so they repo them – stick them in a bank and borrow. Use that money to buy higher yielding corporate bonds. All well and good. Except when gilts prices decline violently and vehemently those gilts no longer cover the borrowings, the pensions funds must ship cash into the banks to cover the loans. They do this by flogging off other stuff.

That’s what was happening. So, Open Market Operations. The Bank of England does this all the time, there’s an entire department doing nothing but. Buying and selling a few bits of gilts here and there whenever. To maintain an orderly market. This is the Mother of All OMOs. About which we can note two things.

1) The BoE has spent £5 billion so far (It’s £5 billion a day starting yesterday). That’s moved the entire market by 1% of yield. That’s a lot, lot, of movement for such a piddly sum. As ever, central banks – those with some authority in the markets – can move markets by what they say they’ll do rather than actually having to do it. Expectations management matters.

2) This is largely a self-solving problem over time. As Andrew Again points out, it’s not possible to repo for decades. These arrangements have to be reset every few months at least. As they are reset then they’ll be reset at the new prices. And with a very decent slug of expectations about near future prices too. Absolutely no one, today, trying to repo will be offered the sort of terms that were on offer a week back. So, over time the prices of the repos, thus the margin calls, reset as the entire market reprices. The problem of haemorraghing cash solves itself over the time it takes for repos to mature and reprice.

This is OMO, it’s not QE.

Now, it is true that if the BoE doesn’t reverse these actions when the market is repriced then the money supply effects will be largely indistinguishable from QE but that’s another matter – something that we’ll find out.

But while Mother of All etc, OMO is a known and necessary function of the BoE. The scale might surprise, but the essentials of the action are pretty normal.

Now, of course, we’re going to get the Potatorous Insistence that this proves that printing more money is the only possible solution. But that would be to confuse two very different things. We can have strategic problems, long running ones. We can also have tactical problems. Short term. Either or both can be dangerous, of course. But as an analogy – and analogy, no more – think of a bank that is illiquid as against one that is insolvent. The first is a tactical problem that is easy for a central bank to solve by supplying liquidity. The second a strategic one which the central bank should solve by an orderly liquidation and the shareholders lose everything, Har Har.

This is a tactical problem brought on by the vehemence and speed with which gilts prices have changed. It’s not a strategic one about the size, depth or pricing of the gilts market.

Well, so far at least. And as a tactical problem it has a short term solution. The big test here (for Jim especially) is whether the reversal of the solution does in fact happen on time.

Ah, one more thing:

On Wednesday afternoon it started by buying around £1bn worth of long-dated gilts, bonds issued when the Treasury wanted to borrow for 20 years or more, having offered to snap up £2bn. It can buy up to £5bn a day between now and October 14, when it said it will stop the programme.

They’ve spent £1 billion so far. That’s £1 billion in a roughly £2 trillion market. Which has moved the yield on that entire market by 1%. Expectations matter, eh?

15 thoughts on “Open Market Operations”

  1. “This is OMO, it’s not QE.”

    Keep telling yourself that, its better than having to admit to yourself that you were wrong I suppose.

    “The big test here (for Jim especially) is whether the reversal of the solution does in fact happen on time.”

    Ah, its my problem now is it? Who was the person who said just a few days ago ‘QT starts in November’? And who was it who said ‘No it won’t and they’ll be buying gilts by then instead’? I think the person who has a problem is the the person who has been proved wrong, not the one who was right.

    You’ve been led up the garden path by the idea that these people will follow ‘the rules’ and its all just a technocratic operation, and the pointy heads know what they are doing and its all under control. When in fact the ability of the BoE to react with money printing to any market turmoil has created a whole new paradigm in the political management of the economy. Now any time the pols do anything that spooks the market they know the BoE will step with its magic money tree and smooth over the cracks. They did it over Brexit, they did it over covid and now they’ve done it over a media induced market tantrum about a tax cutting budget. Notice how the reasons to start printing money again are getting less and less significant?

    My question is this – what policy could a UK Government now enact that caused market mayhem and the BoE would say ‘Sorry, you’re on your own, you created this mess, get yourself out of it, we’ve got the long term stability of the currency to think about’? What if a Corbynite government wanted to borrow £1tn to pay a UBI? Or a Eco-mentalist one wanted to borrow trillions to ‘Go Net Zero in 5 years time’? Where does the Bank draw the line? Is there even a line? When does it say to a government ‘No more money printing for you’?

  2. Bloke in the Fourth Reich

    So perhaps, don’t repo so much that you can’t cover with a fire sale of gilts rather than profitable or illiquid investments?

    The fundamental problem is government debt is a shit investment, because interest rates. It’s a policy decision, as is the inflation we are going to enjoy much more of.

    Pension funds are subject to rules? Of course! Well, they need to balance profit maximization and risk minimization, within those rules. Being so massively illiquid (which is not exactly a huge cost with >10 years of close to zero interest rates) that you are at such risk of going insolvent between morning and early afternoon because of not merely predictable, but widely-known and pre-announced events, is lunatic-level irresponsible and shows that your pension is in the hands of morons.

  3. Bloke in the Fourth Reich

    Incidentally, I’d love to cash out my various employee pension schemes. They are all worth very little and I’d get a much better return investing the money myself. I see no reason to be forced (or my employer to be forced on my behalf) to stick money in a scheme with bugger all return.

    Looking at the world I might just invest in some fine and ancient malts which I can sip on the balcony while watching the mushroom clouds.

  4. Presumably we’re talking about DB (defined benefit) pensions only – but how many of those are left these days? As far as I’m aware, all the big corporate ones are closed to new entrants. Or does it also include horrors like the local government pension scheme?

  5. It *was* credit sales by funds on Monday and apparently someone making a call to the Regulator which triggered this. Buying opportunity on Monday was huge as bonds were dumped for quick sale.

    We’ve posted a 10 digit sum in collateral this week SO FAR. Our regulator asked us for a ‘same day’ call on the market and liquidity early this week and they talked about pension schemes (who we do a LOT of business with) which was before the BoE intervention.

    BoE stepped in for market management and financial stability NOT for QE. So Tim is correct. That said the money printer going Brrr is pretty much most government policy nowadays. Heaven forbid someone actually takes any spending from the State and lets us decide where it should go. That’s the escalator that we are on to insane tax rates and a dead economy.

    As for Pension scheme risk management. Trustees outsourced investment management in most schemes except the very largest. In fact they’ve outsourced pretty much everything. Good risk management costs money so the return you expect goes down, except the losses you don’t expect go up. This is the opposite of the Goldman Sachs way of doing business. They identify every last risk, and then make another firm responsible through very clever negotiation on the details. Pension schemes are amateurs playing a very professional game and thinking having lots of zeros means they are in finance.

  6. “BoE stepped in for market management and financial stability NOT for QE. ”

    Thats how many angels can dance on the head of a pin territory. ‘The BoE buying gilts with made up mony isn’t the same as the BoE buying gilts with made up money when we call it Open Market Operations rather than QE’

    Pull the other one, its exactly the same operation, it has exactly the same effects, regardless of what label you stick on it.

  7. Bloke in the Fourth Reich

    So does this mean that pensions are largely already run the way the Sage of Ely would have them run?

    Just he’d find government debt that is both more risky and has an even worse return?

  8. So, with an oncoming environment of high inflation reducing the value of money, high interest making borrowing more expensive, a recession reducing the availability of employment, age reducing the enthusiasm of employers to consider even thinking of employing me, fifteen years away from being able to draw my pension, but with less than 20% of my mortgage left, I’m wondering what options look best to stay alive for the next 40 years.

    I’ve been trying for ages to get out of the slog of relying on other people to pay me to stay alive. Refusing to work until somebody pays me to do what *I* want to do hasn’t worked, doing what other people /are/ prepared to pay me to do hasn’t got me to the stage of being able to stick two fingers up at them. I loathe the thought of debt, but high inflation does make piling up debt and living off that attractive – unfortunately, lenders require you to actually have some means of paying that debt before giving it to you.

  9. Andrew M – the FT article linked to in the previous post does mention DB schemes specifically, with regard to the Liability Driven Investing (LDI) process.

    DB schemes might have closed to new entrants some time ago, but they (obviously) still exist as they have to keep paying out (a fixed amount per month) until all the members (and may be some dependents) have kicked the bucket. If the scheme closed to new members in 2000, and the last new entrant was aged 25 that year, then the scheme would expect to begin paying out at age 65, 40 years later in 2040, and the nerk might survive for another twenty years after that, so 2060.

    Presumably, there’s an overhang of more pensioners receiving than current employees paying in somewhere in the timeframe (2005? 1995?), so cash in no longer matches cash out, and the fund ends up having to chase income or capital gains within the gaps – I think gilts generally pay semi-annually, April and October, so a fund with 100% in gilts would have cashflow issues for ten months of the year.

    For DB, the scheme manager might not be able to reasonably estimate what level the final benefit might actually be, so they’d have to chase capital gains or ever higher yields as well. So Brown’s pissing about restricts the managers’ ability to do that.

    From the FT article, I’d guess that the DB schemes got hit first, and contagion to other credit funds followed.

    (Is there a Last Man Standing issue with pension funds?)

  10. Open Market Operations. The Bank of England does this all the time, there’s an entire department doing nothing but. Buying and selling a few bits of gilts here and there whenever. To maintain an orderly market.

    So the pinnacle of the great mountain of free market activity is regulated by an office of mandarins.

  11. Bloke in the Fourth Reich

    Thanks TomJ, but most of mine are in Germany. I have a small NHS pension pot in the UK, which in terms of return, will be the most lucrative of the lot.

    At the current rate with my German ones I will have to live to about 84 just to get back the cash put in. So I will likely just withdraw the lot lump sum when I hit whatever age…

  12. Can you imagine virtual infinite-capacity wheelbarrows you carry in your pocket?

    Can we use scientific notation to put $infinity on debit cards?

Leave a Reply

Your email address will not be published. Required fields are marked *