Bank on England Warning as Hedge Funds Buy Up Cheap Government Debt

The Bank of England has voiced concerns this week in its Financial Stability Report (FSR) that professional, ‘super tanker’ activist hedge fund investors are buying up £billions in UK government debt (gilts).

What are Gilts?

Gilt Edged Securities (so called for being secure as they are backed by the UK government), are issued when the British Government borrows money.  You will have seen many times in the headlines about the amounts the government borrows.  Gilts (or Government Bonds as they are known in other countries) are where investors like pension funds and banks lend money to the government.  Usually, each week, the government hosts a ‘Gilt Auction’ where investors bid to lend the government money.  This debt works like an interest only mortgage, the government pays interest only (coupons) and at the end of the term, the debt is repaid.

Gilt Yields High

Government debt in the UK, US and Europe is high.  Bank interest rates are relatively high too.  This means that the government must agree to pay high interest payments on its debt to secure borrowing.  Think of this as a an adverse credit mortgage. 

It is cheap for investors to lend for a higher return.  In short, gilts and bonds are cheap at present with high yields (returns). 

Bank of England Concern

The FSR highlighted that rather the the usual investors of banks/pensions funds is that foreign hedge funds are buying up £billions of UK debt.  You may or may not remember George Soros, John Templeton or William Boss), all famed for bond market speculative investing and on macroeconomic trends (big economic shifts), buying up UK and US government debt rather than the usual banks/pension fund buyerrs.

In particular, Hedge Funds are buying up the ‘repo’ market.  The repo market is the ‘repurchases market’.  Hedge funds are buying and holding evermore UK debt holdings on the open market.  This may create instability when/if speculators sell off the bond market.  This ultimately would potentially bankrupt the government if there was massive sell off, driving the ‘market value’ of debt stocks down and yields up.  In short, could the UK government face gilt yieilds/borrowing costs to those faced by Ireland and Greece in 2010-2015?  Some 10%-17% interest rates on debt.

Comment:  Hedge Fund Speculation?

It was Soros who famously ‘bet’ against the £ in 1989, forcing the Chancellor to increase interest rates by 5% overnight.  It was also ‘bond market’ speculators that caused the bond/gilt market crash in 1987, which ultimately caused the ‘Black Monday’  stock market crash in 1987. 

The Bank of England is concerned that Hedge Funds could do the same, we too fear for UK borrowing costs.