The Bank of England may have stabilized the U.K. bond market by aggressive purchases of longer-dated securities a week ago, but it, and other central banks, aren’t out of the woods just yet, according to an analysis from Bank of America. The fastest and most aggressive monetary policy tightening in over 40 years by the Federal Reserve and central banks around the world has “rudely awakened” a highly levered system, said equity derivatives analysts led by Benjamin Bowler.
The need for the Bank of England to reverse a plan to sell gilts, and instead buy them, to save pension funds from going under “should remind investors of the existence of ‘unknown unknown’ secondary effects and force them to price in a thicker left tail in stocks,” said Bower, using the term popularized by the late U.S. defense secretary, Donald Rumsfeld. The Fed also could be faced with a trade-off between fighting inflation and maintaining financial stability, Bowler argued. U.S. stocks rallied for a second day on Tuesday, and gilt yields
TMBMKGB-10Y,
3.866%
have dropped considerably since the Bank of England intervention. But Bowler noted the S&P 500 index
SPX,
+2.79%
hit several year-to-date lows last week as did the FTSE 100
UKX,
+2.57%.
“To us, this is a sign that central bank credibility is already dented, and strengthens our view that the biggest risk to markets is a test and fail of the Fed put.” See: U.K. bond yields plunge after Bank of England steps in to buy at ‘whatever scale is necessary’ The Fed put is the belief the central bank will step in to backstop markets if there’s a swift decline. The Bank of England emergency response, he added, didn’t fix the underlying problem, which is the highest rate of inflation in decades. “In fact …