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MAC Monitor — October 3, 2022

Multi-Asset Class Risk Monitor Highlights | Week Ended September 30, 2022

  • Mixed BoE signals invert Gilt curve
  • Pound rebounds as UK rates outstrip US
  • Co-movement of bonds and currencies boosts portfolio risk

Mixed BoE signals invert Gilt curve

Long British government yields dropped below short rates in the week ending September 30, 2022, as the Bank of England (BoE) bought long-dated Gilts in an effort to calm tumultuous markets in the wake of the previous week’s mini budget, while simultaneously hinting at the potential need for additional rate hikes to bring inflation under control. The Bank announced on Wednesday that it would “carry out temporary purchases of long-dated UK government bonds…to restore orderly market conditions”, adding that “purchases will be carried out on whatever scale is necessary to effect this outcome.” The statement was issued as 30-year Gilt yields temporarily soared above 5% for the first time in two decades, forcing UK pension funds to liquidate assets at a steep discount in order to meet collateral calls. Ultra-long Gilt yields dropped sharply in response and eventually ended the week 40-50 basis points in red. This was in contrast to shorter rates, which had been lifted more than 50-60 basis points at the start of the week by a statement from BoE Governor Andrew Bailey that the “MPC will not hesitate to change interest rates by as much as needed to return inflation to the 2% target sustainably in the medium term.”

Please refer to Figure 3 of the current Multi-Asset Class Risk Monitor (dated September 30, 2022) for further details.

Pound rebounds as UK rates outstrip US

The British pound rebounded from recent record lows in the week ending September 30, 2022, as UK interest rates and sovereign yields climbed above their US counterparts for the first time in eight years. Over the past 12 months, the US dollar has been steadily appreciating against most of its major rivals on the back of the aggressive monetary tightening by the Federal Reserve and the continuous upward revision in interest rate expectations that preceded it. Following Monday’s statement from Governor Bailey and the subsequent surge in Gilt yields, money-market derivatives temporarily implied that the BoE base rate could rise above 6% next year, far outstripping the anticipated peak in US federal funds of around 4.5%.

Even though the Bank of England has not made a formal commitment to defending its currency, there is an implicit warning to potential short sellers, as higher interest rates will make it more expensive to borrow pounds to sell against other currencies.

Please refer to Figure 6 of the current Multi-Asset Class Risk Monitor (dated September 30, 2022) for further details.

Co-movement of bonds and currencies boosts portfolio risk

Predicted short-term risk in Qontigo’s global multi-asset class model portfolio soared 3.1% to 18.8% as of Friday, September 30, 2022, caused by higher volatility in FX and interest-rate returns, as well as a more intense co-movement of the two factor types. Especially the gains for longer-dated Gilts, in conjunction with a stronger pound, boosted the percentage risk contribution of non-US government bonds by 1.3% to 9.5%, while the share of overall portfolio volatility of global inflation-linkers increased 1.5-fold from 4% to 10%. GBP cash also became the riskiest foreign-currency position in the portfolio, with its risk contribution equal to its monetary weight of 2%.

Please refer to Figures 7-10 of the current Multi-Asset Class Risk Monitor (dated September 30, 2022) for further details.