Activity in Q3 2016 principally comprised of new client hedging activity due to a growth of client appetite to de-risk in outright terms, which was an increase on the previous quarter. Switching activity, in which pension funds move between equivalent assets in order to lock in a yield gain, covered the remainder of the hedging activity over the quarter. There was a continued trend from the previous quarter, which saw schemes switching out of swaps into bonds, particularly in real rates. The volatility of the conventional asset swap spread led to a two-way flow as some pension schemes were able to ‘complete the round trip’ and lock in gains.
As part of this quarter’s survey, BMO Global Asset Management asked respondents their views on likely policy and issuance changes to be announced in the Autumn Statement. The survey, which polls the derivatives trading desks of investment banks on volumes of hedging transactions, revealed counterparties are expecting a modest loosening of fiscal policy with a corresponding increase in the forecast gilt issuance. The markets response to these policies, in terms of growth projections or issuance could have a significant effect on long-term yields.
“With the market still reeling from the result of the EU Referendum, the Bank of England (BoE) relaxed its monetary policy in August. Looking ahead, fiscal easing is expected from the Government at the Autumn Statement. However the risks are finely balanced and the reduced liquidity often seen towards the end of the year could result in exaggerated moves in rates.” said Rosa Fenwick, LDI Portfolio Manager at BMO Global Asset Management. “Given the backdrop, our counterparties now predict a fall in the inflation rate and a rise in nominal and real yields, however with low conviction on each metric. This highlights the uncertainty in the market and the impact that monetary and fiscal policy can have on the progression of rates”
“In terms of what this means for LDI clients, there are considerable risks in delaying planned hedging until after the Autumn Statement and it may make sense to accelerate existing timetables,” continued Rosa Fenwick. “An alternative would be to put market-based triggers in place so that even short-term upward moves in yields can be captured.”
The BMO Global Asset Management LDI survey is led by BMO Global Asset Management’s LDI team, a leading LDI manager, and respondents are polled on a quarterly basis.
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