With GBP at historical lows, Bank of England restarts Quantitative Easing

The Pound Sterling has suffered its worst YTD performance since 1985, falling 20% against the USD in 2022. A slew of economic issues ranging from energy insecurity to the highest inflation in decades, have been pulling the GBP/USD Rate lower for the better part of the year. However, the panic set in when a new government budget revealed the most aggressive tax cut measures since the 1970s, causing investors to lose confidence in the currency’s stability and sell the currency as well as government bonds.

U.K Government Bonds, also known as Gilts, saw a dramatic spike in interest rates between September 23 and September 28, with 30-year Gilt yields reaching 5.092% in the early trading hours on September 28th, which represents the highest yield since 2002. In light of the tightening financial conditions observed in the 2.1 trillion-pound U.K bond market, the Bank of England announced an emergency restart of its quantitative easing operations “on whatever scale necessary”, in order to restore confidence and liquidity to the market. The iShares Core UK Gilts ETF, which saw a decline of over 5% since September 23rd, saw a spike of +7% once the BoE announcement was made, signalling some of the market nervousness had subsided, at least on a temporary basis.

Likewise, Gilt yields across the maturity spectrum saw a considerable decline post announcement, especially on the 30 Year Gilt which dropped 106bps, fully erasing the 105bps increase over the last month.

Effects on Mortgages and other Fixed Income investments

With fixed income making up a considerable portion of Pension Plan investments, there has been considerable stress put on Pension Plan managers to get rid of Gilts and Mortgage Backed Securities (MBS) within their portfolios, further exacerbating the initial sell-off. Persons familiar with the decision of the BoE confirmed that its radical change in policy was primarily due to the issues faced by pension funds, which were “running out of cash”.

The mortgage market has also experienced considerable stress since the budget announcement. Hundreds of residential mortgage deals have been pulled off the market, with major lenders such as HSBC and Santander Bank pausing their offerings. Though it is unclear how these actions have affected MBS products, as there are no publicly traded ETFs focusing on UK Mortgages, it does bring up another area of diversification for Fixed Income.

Infamously known for their role in the 2008-2009 Financial Crash which originated in the U.S, MBS products have received a notoriety that is perhaps unwarranted. At their core, they are structured in the same way as any bond or private credit product and are effectively a bet on the ability of the borrower to continue making payments to their lender. Conventional wisdom states that mortgages are at the top of the priority list for most people, and so they generally rate as relatively low-risk investments, especially if backed by the government.

Investors can get exposure to various MBS either through direct investments in Mortgage Pools or through ETF products which provide diversification across a wide spectrum of maturities and credit ratings. Products such as the iShares MBS ETF and the Vanguard Mortgage-Backed Securities ETF are excellent ways to get exposure to this area of fixed income, though investors should always consult a financial professional for more details on suitability.  Other options include the BMO Canadian MBS Index ETF, for exposure to the Canadian Mortgage market which historically has been resilient even through the Financial Crisis

Summary of mentioned ETF Performance (1 month, YTD)

Source: Summary of mentioned ETF Performance (1 month, YTD)

iShares MBS ETF

Vanguard Mortgage-Backed Securities ETF

BMO Canadian MBS Index ETF