from Zero Hedge:
It started off well enough.
On the first day of the Bank of England’s resumption of Gilt QE after the central bank had put its monetization of bonds on hiatus in 2012, bondholders were perfectly happy to offload to Mark Carney bonds that matured in 3 to 7 years. In fact, in the first “POMO” in four years, there were 3.63 offers for every bid of the £1.17 billion in bonds the BOE wanted to buy.
However, earlier today, when the BOE tried to purchase another £1.17 billion in bonds, this time with a maturity monger than 15 years, something stunning happened: it suffered an unexpected failure which has rarely if ever happened in central bank history: only £1.118 billion worth of sellers showed up, meaning that the BOE’s second open market operation was uncovered by a ratio of 0.96. Simply stated, the Bank of England encountered an offerless market.
What makes this particular failure especially notable – and troubling – is that while technically uncovered sales of government securities happen frequently, and Germany is quite prominent in that regard as numerous Bund auctions have failed to find enough demand in the open market in recent years forcing the “retention” of the offered surplus, when it comes to a central bank’s buying of securities, there should be, at least in practice, full coverage of the operation as the central bank is willing and able to pay any price to sellers to satisfy its quota.
For example, in today’s operation, 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, which means that the happy seller obtained a yield well in excess of that implied by the market.
And yet, despite having a completely price indiscriminate buyer, some £52 million worth of bond sellers simply refused to sell to the BOE at any price!
The QE failure quickly raised alarm signals among the bond buying community. In a Bloomberg TV interview, Luke Hickmore, an Edinburgh-based senior investment manager at Aberdeen Asset Management said that “lots of people are bidding us for bonds — Mark Carney is now bidding me for bonds and he still can’t have them. The problem is he was trying to buy 15-year plus bonds today in the gilt market. That’s a really difficult area.”
Needless to say, immediately after the news that not even the BOE can buy all the bonds it needs to buy at any price, yields on 10 and 30-year gilts quickly dropped to new record lows. “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,” said Daniela Russell of Legal & General Group in London, cited by Bloomberg.
We were surprised they didn’t slide even lower. After all, if even the central bank is met with an offerless market, there is simply no price that is high enough, as ludicrous as that may sound, for longer-maturity gilts because the last marginal seller can demand any price from the BOE and they will get it.
As Bloomberg notes, 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. A big part of the problem for the central bank is that it already scooped up about a third of the U.K. government bond market as part of a program that started in March 2009. And, with yields already at all time lows, it has just run into the same problem that we warned back in 2014 will haunt the BOJ: a lack of willing sellers. Ironically, even as the BOJ has stumbled from one monetary policy embarrassment to another, it never had a failed POMO. It was up to the Bank of England to demonstrate what a bond shortage really means.
But why the lack of sellers? Well, 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.
Please follow SGT Report on Twitter & help share the message.