Toby Nangle on What We Just Learned From Gilt Market Madness

to avoid it a feed. That's my excuse. I'm going to start this conversation with a massive caveat, which is we are recording on October three. Things can change in the couple of days that it takes us to get this out, and already things have changed quite a bit. So you know, the week before we recorded this, we saw massive movements in the UK market. So we saw five year guilts at like four point seven percent, which was the highest, and two thousand and eight we saw

an even bigger move in longer dated guilts. I think the twenty year was almost five percent. It's now back below four percent. The pound reached a record low against the dollar. All of this was after the UK unveiled a mini budget that featured a bunch of tax cuts that were expected to balloon the public deficit at a time of inflationary pressure in the UK. Joe, I'm just

going to make that point. But even then, you know, in the one week since all of that happened, we now have the UK Prime Minister was trust coming out and basically doing a U turn on one big component of the mini budget, which was the tax cuts, And so we're seeing some relief in the market, but there's still this big question over what exactly just happened, right, and so it really I mean, the story kind of started on September twenty three when those tax cuts were announced.

It really started accelerating in the middle of the following week the Bank of England was forced to essentially enter the market. And when you have these big in government bond there's always this debate, and you've written about it for years. Another context, it's like how much is quote

fundamental and how much is technical? How much does it have to do with market structure verse some sort of like meaningful signal about the path of expected inflation or the Bank of England policy rates and at times there is a deviation, and it seemed at least at one point last week that there was a pretty big deviation between something like fundamental versus this sort of like technical driven market that may have been causing a run of

sorts in at least one quarter of the market. Right, So we are going to be getting into this technicals versus fundamentals question with really the perfect the perfect guest.

We're going to be speaking to Toby Nangel. He is an economic and markets commentator who worked in asset management for twenty five years, formerly the head of global asset Allocation for Columbia thread Needle, also a previous All Thoughts guest, and someone who is quite philosophical at times over money and what mark, but also apparently can get technical to combine the philosophy with the technical, which is a rare combination.

So I'm looking forward to this conversation. Toby, Thank you so much for coming on our bots, Thanks for having me. So maybe a basic question to start off with, but how remarkable were the events of the previous week or so in your mind? Oh my goodness, yeah, I mean for the guilt market, There's nothing like that in my career, and I was looking back using Bank of England data

and you can't really find something like it. For the part well since the daily data that they have there to have the short guilt market completely repriced the Bank of England rate path in the way it did. And then also the long end kind of go from this big bear flattening into this huge bear steepening as you had liquidation trades and a and a run dynamic unfold with the Bank of England than having to intervene to start buying bonds when it's trying to do QT. I

mean it, there's nothing like it. It's really an extraordinary episode. We need to uh talk to Richard Silla, who you know history of interest rates going back to two thousand. That was one of our first episodes to find something comparable. It sounds like it really was wild. And all someone has to do is look up a chart of like tenure guilt or anything and you just see these multi standard deviation moves that are supposed to happen like one

every hundred thousand years happening a few days. But before we even get to like what was really driving last week, I'm curious, like in the weeks Prior to this, it appears we've been seeing this deterioration of market liquidity, pretty big sell off in government bond markets around the world, strains starting to emerge with so much tightening from central banks, Like going prior to September twenty three, the day of the mini budget, what we're conditions like, what was trading

like in your view in government bonds? So, I mean, you quite right. It's in an environment of rising bone yields around the world, driven really by by the FED, but also what's going on the e CP and what's anticipated to happen in the UK. From what I understand, I mean, liquidity hasn't been amazingly good, but there was nothing that I heard that was pointing to a complete collapse or anything like that. I can see Joe is setting up his his argument for later. It turned out

everything was fine. I have no argument anymore. Okay, okay. So the Bank of England stepped in, which provoked a whole bunch of commentary about things like fiscal dominance, and the accepted explanation or narrative for why they stepped in now is because something was going on with pensions and basically we were getting this sort of like self fulfilling cycle of yields going up, pensions having to sell stuff off and then yields go up more. Can you walk

us through exactly what the issue was there? Yeah? Sure. So in the UK market as the management market, the biggest segment by by far, something's called liability driven investment or l d I. And to understand that you have you need to kind of rewind. Probably about twenty five years there were these moves in the way of this guy called Robert Maxwell, who's probably best known today in

the North American audience for being Jolne Maxwell's father. He yeah, so he ran a media empire, the Mirror Group, and before he fell off his yacht and drowned near the Canary Islands, he'd fraudently taken hundreds of millions of pounds from the Mirror Group pension scheme, leaving those pensioners basically, you know, without a pension. So it's a huge scandal caused of bankruptcy of that media empire and a big

bailout of the Mirror pension scheme. So then you kind of bring in this minimum funding requirement for UK pensions. At the same time, accountancy standards are changing. You have this thing called FRS seventeen, which goes to f RS one or two in the in the UK, or International Accounting Standard i S nineteen for global, which kind of says, do you know what a pension is? Sort of like a deferred piece of payment for an employee. It's like a it's like a long series of zeros, right a lot.

I mean, as in a long zero coupon bonds, So we should probably value them like long zero. So we get a bunch of actories to work these things out and then discount them back using bondials. So suddenly, you know, you had financial statements that were full of fluctuating pension fund mismatches of assets and liabilities, and at the same time you had this regulatory pressure to say, you know, you probably don't want to have your pension fund hugely underfunded.

You can invest in anything you want, but if you've got a big funding deficit, then you've got to present a recovery plan, which might mean over that period you can pay no dividends, you can't do em any m and a we might say you can't change people on your board. All these kind of things that firms don't want to do, and so firms go, well, how do

we deal with this? And number one, they kind of shut down their pension schemes for new entrance, and number two they look to better match their assets and the liabilities, their liabilities looking bond like. So this is kind of like the deep history of it. Now, what's has got to do with derivatives? And last week, well pretty much almost every pension fund couldn't quite afford to match their

assets and the liabilities. So what they do instead is they they have a growth portfolio which is kind of low volatility that they should beat cash over time, and then they've got a matching portfolio and that might be long data guilts. Now the liabilities look a lot like long dated guilts in so far as a long dated about twenty five year duration instruments, right, but they might only have like in the matching assets and in low

volatility growth assets. So what they do is they put an overlay over the rest of it, using swaps or doing kind of repo on that on that matching portfolio to to to generate leverage. And the leverage varies a lot, like you know, it would be up to like of a four four times for the larger schemes. What gets through the mechanics? Actually, yeah, what happened, Setting aside the craziness of last week, what happens mathematically for the pensions

when rates go up as they have been this year. Okay, okay, yeah, So if you have a pension fund, it's called assets, which will be financial securities and other stuff, and then we have liabilities. So let's say at the beginning of the year, your pension fund and your assets are one hundred, and your liabilities are hundred long dated bond yields rise up, you know, a lot. Let's say there rise a hundred basis points in your and your and your liability to

got duration. So now your liabilities are only seventy five in present value terms. Now your assets they would have maybe fallen a bit because great hasn't been fantastic, but also on the on the liability side, those guilts have been worth less, and then the swap overlay is worth less.

So what mathematically will have been happening during the year is it pretty much every month they'll probably be rebalancing so that they get back to being fully hedged and they don't have any kind of crazy stuff going on. So Just to be clear, the value of the assets has in a rising rate period, the value of the assets has fallen, but if it's orderly, it's okay because by the accounting standards, the total value of the obligations

has fallen as well. Absolutely. I mean, we think of pensions as investors, but what they're really trying to do is they're trying to solve their problem. And their problem is that they don't want to leave their beneficiaries with an unsecure outcome, right, So that means that they don't go around going, oh, how do I duce a little bit more out of this? Or that they're thinking how can I get my funding ratio into a better place, And if they've got their funding ratio in a great place,

then they don't really care what yield are doing. So this is like, you know, it's fine ld I works fine in low yield environment, it works fine, and high yeld environment it doesn't work fine if you move from a low yielding environment to high yelding environment super super quickly, And maybe we should have a look at them account to that. Well, So this was going to be my next question, what exactly how happens in that scenario when you get a sharp move or yields move very quickly.

And when you have that type of volatility, is it a problem because of the optics related to the pension fund? You know, no one wants to say that they're underfunded and then have a bunch of press written about that, or be restricted in what they can do going forward, or is it a problem in terms of technical stuff that they have to do, like stump up more collateral to cover some of those swaps that you just described. Okay,

it's it's the second one. But also importantly, in a thing which hapn't said yeah far, it's quite important, is that they tend to actually be underhedged. So rising yields actually helped their funding ratios, so that that kind of hypothetical scheme in the beginning of year, which had a hundred assets and hundred liabilities now has seventy five liabilities. It might actually have eight assets rather than and so it's actually in a much much better funding ratio than

it was before. There's this being windfull gain that's come through even though the assets are fallen. Right, it's winning if you like. So from the optics, the optics are good, but then there can be the mechanics and like really annoyingly, there are kind of three different ways at least which they kind of implement, but let's just focus on Let's

focus on like two max. Ok So, one of which is that they they implement directly, so they have that matching pool of assets like guilts and then the growth pool with like a swap overlay or repo on on the matching assets. Now they've effectively got gearedlong data guilts, and when guilt prices fall a lot very quickly, that's

gonna make the collateral worthless. Also, the P and L on the derivative overlay will be sharply into negative, so you're going to have to put up more collateral and the collatteral is worthless um and and so that's gonna be a problem that there's going to be liquidity situation there. It's not a funding solvency or funding ratio issue, but there's a liquidity problem there. So that's that's one route.

The second route is something which I think a lot more schemes have had problems with, which is a they're not big enough to have is doas in place with the counterparties and then having like swaps going place. So what they do is they go to a an asset manager that has a solutions are and and the asset

manasion says, you know, I'll tell you what. We'll take a hundred pounds and we'll put seventy five pounds in this growth portfolio, and we'll put twenty five pounds in this pooled leverage matching fund which has all the leverage within it and there's nothing outside that along with like

a hundred other pension schemes. Now, if you as a pension scheme with your hundred pounds, you've got liquidity to make sure that you can put in more collateral if you need to, because you know your your funding ratio is improving. This is great, and so you all set up fantastically. But maybe some of those other schemes they don't have liquidity. Maybe they're invested in private credit or infrastructure or other long term types of things which don't

have great liquidity. Now, if the asset manager says, okay, you know, we've we've got we've got to recapitalize nation events, so you need to transfer more funds in, then they're unable to do anything about it. And so they heads just starts to fall away, even if the whole structure

within those pool funds is maintained. But the asset manager sometimes might even kind of go, do you know what, Like, you know, we're not going to get recapitalization for most of these, we might just decide to deliver them ourselves. And that's what you saw, I think one of the announcements over we can come out from a large asset manager. I just have a million questions, but I'll start and

just to sort of recap what you're saying. You know, sometimes in market, sometimes I'm skeptical of it, but sometimes in market people make a distinction between a liquidity crisis

and a solvency crisis. And so just to be clear, what you described is it seems like a fairly clear example of what should be categorized as a liquidity crisis, because in some cases maybe the move and rates improved the overall solvency and created a gap between the value of the assets today and the applic asians, but the mechanics of it, and you just you know, there were several different avenues. This really sounds like liquidity was the

key issue here. That's absolutely right, Joe. And moreover, the only route for liquidity for some of these was actually selling long dated guilts or unwinding long dated swaps, which which kind of then then boils down to like you know this the Bank of England when they intervened, they weren't doing it to bail out pension schemes. It might actually, I think, I think, actually genuinely it will have disadvantaged

large numbers of pension schemes materially by their actions. It tracy, you know, I'm thinking it feels like this is actually a common theme this year, and I'm thinking, like some of the commodity volatility that earlier in the year, where you have these commodity producers they were actually benefiting from a sort of solidcy basis by the fact that commodities were surging, but due to the funding cost of their hedges, were risk of going bankrupt despite favorable commodity right, and

also just the pro cyclicality of margin calls, which is something we also saw in the commodities market. Okay, So on that note, Toby, you just mentioned the BOE coming in. What exactly did they do first off, and is it quie or not and why does it matter? And then secondly, what impact has that had on the pension fund. So you mentioned that it might actually have been negative for them in terms of a funding perspective, but it would have broken the liquidity margin called doom loop that you

just described. Yeah, that's that's right. So the Bank of England they saw that this doom look was in place and that you don't know where that's going to lead, right,

that could that could undermine the entire financial system. So they intervened with an announcement that they would do daily auctions of up to five billion pounds each in long dated securities, and they did their first auction and I think it was like just over a been was was was offered, but the announcement just collapsed long yields by

a hundred basis points, I mean a huge move. I mean, if you've got twenty five year duration in this stuff, that's a percent price jump just on the announcement, which is just phenomenal. So so that's what they're technically doing. Is that quee um. I think that technically you could talk about it as balance sheet enlargement, but I think it's it can only be understood as a lender of last resort, or rather market maker of last resort function

that it's stepping in to do. It's protecting the financial system. It's not trying to reverse QT in it anyway. And you know, I think actually it was. They executed it and the results are probably way beyond their expectations. And then the second question was about like what was the impact on pension funds. Well, some some of these these pension funds will being cleared out of their hedges, whether through their choice or through their managers choices, up when

long dated yields were above five percent. And so if you think of that, you know that fund that's feeling really great because it's it's assets are fallen by year to day, but it's liabilities are down twenty five year to date, and you have like the assets and liabilities going up and down in this roller coaster together. Well, the assets just fell out when the game unbledged and the liabilities rose back up hugely after the Bank of

England intervention. And so that windfall gain which might have come from rising yields, because that's a little bit under hedge. I don't know the impact like system systemically, and I don't think anyone knows the impact systemically yet as see what the hits being for them. Hopefully it's small. I think in the macreconic terms it will be small, but it will be hugely painful for for a number of schemes.

So I'm thinking back to in the US in UH and I guess elsewhere, but in the US and spring on set of the pandemic, and it was a similar situation with leverage hedge funds that are cash treasuries versus futures, and the FED head to step in and restore calm to the market. And then you know that people have talked about the idea of like a standing repo facility such that at any given time you can just get liquidity for what, within any given systems should be the

safest most liquid asset. Would something like that in the UK had it? Is there anything equivalent to that in place? Or would something like that be useful such that the central bank doesn't have to make ad hoc decisions about when to step in, but allow players to at any time get central bank liquidity for their guilt. So I don't think that there was I mean, I could be wrong, so I'm gonna caveat that, but I don't think that

there was a problem about getting liquidity feel guilt. I don't think that people were wondering, you know, how do I, how do I get finance for this. It's more that owing to the structure of the leverage, the value of the guilts had had reduced such that, you know, they

just didn't have enough collateral. I mean, consultants will we talked about you know, I was speaking to a c i OVA of an investment consultant for a piece I read in in July setting up this whole yeah, concern about l d I. And he told me, listen, one of my clients had one point five billion pounds of excess collateral when guilt yields were down at the lows

during the pandemic. They've now got zero and they need to get another billion pounds collateral call to come through, so they're selling things that was in June, right, that was the effect of what had happened through then. So you had let's say that twenty five which was guilts, you might have only needed ten to put in that pot for collateral, and that then fifteen could have been excess collateral. Then you know, as as yields rise, so your excess collateral shrinks down and then you need to

replenish it, you need to rebalance. And these things can happen, you know, they can. It can cause a little bit of strains on the system. But they can happen over months, but they can't happen over forty eight hours. So speaking of collateral calls, which is basically a synonym for forced deleveraging, I know, we we talked about the sort of doom loop of you know, yields going up and so pension funds have to sell more guilt and then that forces yields to go up more, particularly at the long end.

But we've also seen some chatter about other assets being sold to satisfy these margin requirements. What have you seen there? I've seen talk of credit, you know, specifically some e t F given that they're more liquid than underlying cash bonds. But also I've seen people talk about the impact going as far as the Australian mortgage market. Last week, Yeah, yeah, I saw Australian rnbs that go on bid in project credit. Yeah, absolutely,

that's far an offer. I'd say that the vast majority of large pension schemes which are in the UK market, large I mean l D I liability driven investment comes around. I mean covered at the last count, which will be smaller now about one and a half trillion pounds, but that would be like out of close to two trillion pounds worth of defined benefit pensions. So these are the kind of magnitudes and now the vast majority of them will have come through this and feel, wow, our strategy survived.

You know, we didn't get into forced the leveraging. This is fantastic, and they'll feel really great about that, and I think that's good. But then they'll look at their asset allocation and they just go whose asset allocation is this?

You know, this doesn't look like my asset allocation because it was all pulled so out of kilter by the changes that have occurred, not in the market values of the of the additional things, but rather you know that the bond portion is shifted around, the portion allocated to liquids will be much higher than they'd probably had in their policy, and so there will be this process of how do you get back to where you thought you were? And that's going to be kind of the next the

order of business for the next few months. And can we beg We mentioned you had your your head of asset allocation at Columbia Threadne Can you just talk a little bit more for the You know, Tracy and I have known you for years. We've had you on the podcast Smart Guy on Details, Smart Guy on big philosophical questions about the definition of money. But maybe for people who are listening to you for the first time, can

you describe what you did? But also like, what is the sort of normal state of the guilt market, who is trading them, who owned them? And like what is sort of like the the ecosystem of guilt holders and traders. What does that look like in normal time from your perspective. So, yeah, I used to be global head of as apllocation at Colombia thread Needle, which is a large investment firm. My team managed what about a hundred and sixty billion dollars

across teams in four time zones the UK. Frankly, it is a fairly small part of that global that global area, but I had quite a lot of contact because a fund I managed, I mean, it served as a growth fund for pension funds that we're looking at liability driven investment, that sort of thing. So so I had conversations with pension fund trustees and and and consultants over the past sort of ten fifteen years to understand the kind of aims and ambitions that they have and how they're trying

to implement these things. And in terms of the guilt market more generally, the guilt market is I mean, the UK defined benefit pension system is just very large compared to the amount of fixed income out there. I read I read a piece a few years ago which I haven't revisited, which was looking at the amount of duration in Sterling denominated instruments and comparing it to the duration of defined benefit pension schemes, Like if they all wanted to just allocate to bonds, could they know? Is the

answer there? Simply isn't enough UK to or at least there wasn't enough UK duration for them to do that. They would have to take basis risk, They would have to go out and think of other strategies used derivatives in order to try to get towards that kind of locked funding ratio. I know we've been focused on pension funds for the most part, but in terms of those overlay strategies used to pump up leverage and therefore pump

up returns. I mean, this was one of the suspicions about some of the big bond funds for the past ten years or so. Um, I'm thinking of one in particular selling a lot of volatility, you know, taking on a lot of duration risk and things like that. How endemic are these overlay strategies to asset management in general? I don't think that they are particularly endemic, I mean beyond the largest portion of the UK st management industry, which which is a livelit d of an investment side.

But I think it's really really important because I realized you said at the beginning, you can get really that's okay, and I have done because you know, I'm part of your your audience. I listened to your podcasts. I love it. And I think lots of super geeky people do no offense to the rest of the audience. Geeks unite. But one of the things which I which I'm seeing in the mainstream well all across the main seam press in in the UK, is that leverage has been used to

deuce returns to pump up returns. It's and that's not really what's going on here. What's really going on here is that there isn't enough UK fixed in come duration and it doesn't seem necessarily unreasonable to think about a recovery strategy for UK pension scheme which uses which uses synthetic duration to help you get there what's been I think the lesson that will be taken away from here is that you need to have way larger cushions in place, sort of basis points to exhaustion, if you like, on

your derivative platform in order to know with confidence you're going to be able to implement it properly or you're going to have to have a much more liquid portfolio, which flies in the face of everything the government's been trying to do over the past few years to try and incentivize pension schemes to invest in infrastructure or property or venture capital or all the sort of things that

might help the country's growth profile. That's kind of like going to reverse now, I'm going to up the geek sticks. Now it talk to us why there isn't enough supply of duration, because this is something that you hear in the US as well, although you know a lot of the commentary there is about the Central Bank having suck duration out of the market by purchasing MBS and other bonds.

So yeah, I mean I've had this conversation about like, why isn't a more duration in the UK market for with various of degrees of success me trying to find the answer for the past twenty five years. I've spoken to you know, past heads of management office, the UK governments, different corporate treasurers, and where I've sort of got to on this is that actually, yeah, I would agree with the UK government that the UK government issues way longer

than any other government. So the term structure of of guilts is just hugely longer than any other G seven government in orld, or in fact, I think any government in the world, and that's partly trying to satisfy that first duration at the same time and his balance a question which I didn't answer sorry earlier, Tracy, when you said, well, who else is in the market the guilts? Right, So the shorter part it's insurance funds, and longer part is

all pension funds. The middle part is fairly sort of makant really, So yeah, the UK govern already excuse their in terms of corporate bonds, now, the corporate bond market in the UK is just really tiny there isn't a huge amount of bond borrowing by UK companies, and I was kind of thinking, well, why, I mean, there's sort

of doing this through having an unfunded pension scheme. And then it sort of struck me, well, maybe maybe they've decided to do their long dadd corporate boring through an unfunded pension scheme because the fees that go to the Pension Protection Fund, which is our version of the PBGC, might might actually be kind of lower than the aggregated you know, the spread that you might pay. This is what I mean by Toby being both technical and philosophical

at the same time. I like that, you know, it sounds like if there's a shortage of duration, then the government should enact a budget that increases guilt issuance by Weren't they just trying to solve a basic problem there? But in all seriousness on that point, I mean, it's kind of a troll but also not really like what

is it? What was it about that announcement? You think that was so like, this is what I'm still trying to wrap my head around, right, and why I was I trying to um, you know, what I was asking about? What were liquidity conditions in the days run up to it. What was it about the announcement? Such violence in the market. So, I mean I was watching the announcement with with a bunch of fellow geeks, you know WhatsApp group, and we were looking at and going oh my god, oh wow,

as he was announcing these things. But if you'd asked me before, you know, if I had been that guy who's put into number eleven saying so here's what we're gonna do, I go, wow, that's that's really that's a bit of a shocker. If I was asked like, what do you think the market is going to do? I wouldn't have said what it did, right, you know. And so I mean I think that you can explain what happened by by two things. And this is kind of like,

you know, it was partly the substance. I think that's definitely part of it, but it was also the style. So you know, I mean that the new Prime Minister, Liz Traus and her chancey Chancellor Quasi Quatain came to power and Queen immediately died, and so nothing happened at all, but they wanted to do stuff before Parliament sort of went into recess. Now they're pretty iconoclastic in their style. During the whole leadership campaign, the Prime Minister put the

Bank of England mandate into play. On the first day in the role, Quasi Quantain sacked Tom Scholar, who was the most senior respected official in the Treasury. From their perspectively, be proud of the establishment. He Quasi Kana announces that it will be a physical event and it wouldn't be a budget because you know, the o B are the

Officer of Budget Responsibility are version of the CBO. It has to look at budgets, it has to kind of put forecasts out and it's like, you know, he didn't want his homework marked by them, right, So all of these, all of these sort of stylistic things come through and then you make a sort of a big, sort of shocking announcement which is way bigger than anyone was expecting.

And the gild market seemed to have have a bit of a bit of a meltdown straight away, as the Bank of England was already you know, hiking rates and as you said at the start of the episode, rates around the world are already rising. And then over the weekend, you know, so Friday that was the biggest move and yield in thirty five years, a huge move. So and then so over the weekend KWASI Kartin's interviewed and he

doubles down. He's like, oh, we've got new unfunded tax cards to add to this, and he's you know, he's jocular about it. So so Monday you have a bigger move and you had on Friday, you know, the even bigger move in thirty five years. That the style is really important, you know, if there's this kind of feel to markets, which which I think I don't. I don't think it's like putting a slide rule and saying, you know, you do this measure, you get this number of basis

points rise. It's it's it's the style is important as well. And that's why I think that's today in coming out and doing a major U turn after everyone's saying they were going to do. I mean, the Priminister was on I was on National TV yesday saying we're absolutely not going to U turn. This is absolutely you know what we're going to do. And then there are mid the middle of the annual party conference right now to come

out and you turn. I mean that's a that's a big kind of like, okay, the styles over, you know, we're changing now, this was going to be my next question. Actually, um, you know, if it's more about the style and you know, it really seems like there is a lack of a cohesive plan at this point, you can argue that maybe you know, some aspects of it makes sense, and I know Joe has been doing his share of this on Twitter. Didn't.

But like after the U turn, we have seen bond yields start to come down, we've seen sterlings start to recover. Should that be the right interpretation of the market that like the problem is solved now it's it seems if it's a problem of style and the UK government not really being sure what it's doing here, then that kind of U turn doesn't necessarily bode well. I think the big important U turn is on style. But there was also a substance return for for your listeners who were

not in the UK realm. There was this idea of of scrapping the top rate of income tax, which is fort on over a hundred and fifty thousand pounds, so you only you know, the top rate would be somewhat lower than that that was only going to cost two billion pounds a year. I say only two billion pounds a year, but there we go. It's it was a

small part of that forty five billion package. But today they also said, right, well, we're going to freeze various other budgets and and that will deliver eighteen billion pounds of savings. So put those two together. That's actually there's

some substance there as well. You know that the market was looking for around about thirty billion unfunded tax cuts and that would be using up all the fiscal room from the previous O b R financial projection, and so it was it was a thirty five up to forty five.

That was an element of surprise. And so the substance has been in, you know, fully unwound in a way which I think a lot of people here will be horrified to find the public services which are falling apart, are going to be impacted as as a way to to kind of pay for some of the other unfinded tax cuts. And then that sort of chef's kiss of tax cuts for the very richest has been removed. And that's very stylistic. You know, I'm looking at all these

charts on my screen. And again, if you just sort of put a hand over on the screen over last week, you have a bunch of lines almost where they were before the tax cuts at this point. And I think it was you though, and you've written like in the last week, I think like five or six blog posts and been a must follow on Twitter as always, But I think it was you that saying something like you can't. Did you say that you can't unburned toast? Was that

your line? Yeah? So so what does it mean starting now here like October three, when people are thinking about you know, we talked about, oh, well this move should only happen once every hundred trillion years or something. No one said that, but like now we've seen the move. We now we seen that it's possible now that we can we can't unburn that we can't un see it even if I put my hand over the middle of

the screen. So what does it do for managers? And they're thinking about risks that such a move are now proven to be possible, right, right, So there's this huge kind of efficiency versus resilience sort of battle, right, And one of the things that the UK government was keen to do is to reform solvency to which is a bunch of insurance regulations, so that they would need to have less capital dead capital sitting at the sidelines just

in case. You know, it's part of resilience and you know what what they might well go through that and maybe that's even so sensible. But from a risk manager's perspective, that's using I mean, all risk models pretty much are fed with with historical data sub description, and this is

now in the history. So every stress test that the asset managers or investment banks used, which are kind of different, like scenario stress tests, you'll have one which will be you know, UK has a bit of a meltdowns as one of those sort of stress tests, and you'll need

to make your portfolio survive that stress test. From now on, if you have portfolio risk that you're looking at within your portfolio risk system, your portfolio might look a little bit riscue than it did because simply that historical data is feeding it. And so if you've got a risk budget that you're working to, you might need to take

a little bit less portfolio risk. I mean, that's it's it just kind of goes into the into the plumbing of risk systems on bank trading desks and portfolio managers, and it'll fall out eventually, you know. I mean, these things tend to be like exponentially weighted, um, so after a few years even it'll it'll kind of be a very modest thing, be more on a discrete scenario side. But this now exists on everyone sort of blotter, and it's going to inform decisions, whether people think about that

consciously or whether it's just you know, underneath. So this to me is the sort of big picture change that's happened over the past couple of weeks, which is this idea that we're all coming to grips with severe interest rate volatility, and we can see government bond yields that are usually assumed to be relatively stable move very quickly and very suddenly. And we've designed an entire financial system

around the assumption that that doesn't happen very much. So we have a lot of bank capital rules like quidity coverage rules, pension fund rules that tend to herd investors into these stable and ostensibly safe government bonds, and so when that doesn't happen, when they turn out to be really volatile, it becomes extremely painful and in some circumstances problematic. Is that, like, is that something you would agree with

or how would we resolve that tension? The idea that you know, most big investors are supposed to hold a whole bunch of government bonds, but then you know, we get a week like like last week, and suddenly those remant bonds turn into a liability. I should be careful about using liability when we're talking about pension funds. But you know what I mean, yeah, yeah, yeah, I mean I think I think you some are brilliantly fantastic communicator.

I would just carvat a little bit, just in spirit of geekiness, in that you know, four full pension funds, the long end is the risk free asset simply because that's where the liability sit. But you know, so on on an unleveled basis, you're having a load more. If there was enough duration, would would be a would be a great, great thing for them. I mean, they would be able to close the fund ration and that's it. But because that market structure doesn't really facilitate that to happen,

then yeah, that's going to be a problem. You know, just going back to earlier Tracy as like, well, how should we sort of conceptualized or categorize the BOS intervention shouldn't be considered quie or not? Or is it just some other kind of market operation. If guilt government bonds are the like by definition are the definitional risk free asset, then the central bank in any country can't just let

them deviate too far. I mean that people talk about a bailout, but essentially like it sounds like they they just have to step in. Yeah, I completely agree with that. You you have to have a government curve, you know, without that and nothing else works. Right. Also, I mean the sort of striking thing is there's a lot of talk about central banks losing control of the long end of bond markets, but then, as you pointed out, when the BOE announced its intervention, it actually seems to have

had more impact than it might have expected. Yeah. No, absolutely. I mean if people talk about losing control of along and it's not something that that the Bank of England would typically want to have any control of at all. They'd want market expectations to shape that. But getting into a doom loop is going to be something which will cause systemic problems potentially, and so as a as as the lender of last resort or market maker last resort, you need to step So, Toby, we're going to have

to wind up our conversation now. But I guess just going back to the big picture of what's going on with the UK government and UK market, what are you on the lookout for for next steps or developments that

might inform the future path. So I'm kind of on the pension fund side, I'm sort of thinking that a bunch of pension funds will unfortunately have lost their hedges and so you know, will they be coming back into the market to actually buylong dated bonds in order to know which could cause a real rally from here at

the long end. Some people I speak to in the market on the investment consulting side and hedge funds side, they're they're sort of thinking, right, is there going to be some kind of stop loss safari that goes on? Because that's a great term, because you know, what was revealed during this whole debacle was that actually, if you push up long dated you US boy a hundred basis points,

you can throw some of these structures into unwind. And so I think schemes are trying to manically make sure they're in a situation whereby once the Bank of England intervention ends, that that's not going to be possible anymore. So that's that's going to be very interesting to watch, al right. I love the idea of going on a stop loss Safario. It's not as fun as it sounds, all right, Toby Nangle, thank you so much for coming on. Odd lots, fantastic to talk with you as always. Thanks

for having me. Great to speak to you again. Thank you. So it's been too long to well, we'll have you on. We'll have you on again, tune to talk about how to stop lost so far as go. But that was great, Joe. I thought that was a fantastic conversation and it did actually, I guess, help in my mind crystallize some of the there's been so many big ideas floating around based off

of the price action that we've seen over the past week. Yeah, I just think it was very helpful just to get that distinction between liquidity verse solvency and the context of pensions, because it's easy to sort of like have this cruse. It's like, oh, the pensions, they have a lot of guilts.

The value of the guilts plunged another insolvent. Actually they're not unsolvent in large part because by the conventions of accounting, their obligations went down to But this theme and the fact that we talked about it earlier in the year, like five months ago, with the commodity markets, we see how really fast moves in leveraged areas can create liquidity crises,

even when the fundamentals aren't so bad. Right, And this kind of gets to the central bank point that Toby was making as well, which is as as fun as it is or as bizarre as it is to watch a central bank that is ostensibly reducing its balance sheet and embarking on quantitative tightening actually go back into the market and start buying bonds. That's the role, right, Like that is the classic lender of last resort. You see a liquidity issue like this, not a solvency issue, a

liquidity issue, they're supposed to step in. This is really key and I tend to think that this is where, you know, I get a little frustrated with some of the commentary because central bank is part of the modern financial infrastructure, and so I think people like to pretend that like, oh, like real capitalism or real markets is when the central bank is hands off and then you know, let the chips fall where they may. But I think, like, you know, part of this, the central bank does exist.

It's coret of the system, and part of its role is to stabilize, especially the government bond market for very good reason. I don't think that per se means it's like cheating or a bailout or I'm not I'm not convinced that these are like useful terms when describing the central bank playing its role. Now, I think that's right. What I would say is it does seem like a

very calmmplicated place for the BOE to be in. And you know, the idea that tomorrow we could wake up and the Conservative government has made some new announcement or a new U turn, who knows, and the b o E is going to have to try to formulate the correct response to that. Like that does seem tricky. I completely agree, And I would say there's two things. One is every central bank right now is an inflation fighting mode, right none of them want to be using balance sheet policy,

you know, they're all like QT of some sort. And so the idea that like this is gonna put qt on hold, or that they might even have to expand their balance sheet. I think is an uncomfortable position to put in. But what I would say, also to your point about responding to policies and something could change tomorrow. There could be a new tax cut or two high

tax hiker. Who knows, We have no idea. But what I would say is, you know, I think going back to this, it's like, can they respond on the inflation side of the mandage? So if there's more spending or more tax cuts, okay, we're gonna have to hike rates to hit target high grates further while also with you know, with the left hand, while with the right hand making

sure markets stay stable. It's a tricky situation. Well, this kind of goes back to the whole designing a financial system around government bonds thing as well, and I think it was Connorson had a great tweet about how you know, it's not just the financial system, it's monetary policy as well. Like monetary policy works through changing the price of government debt.

So if you want to change employment or inflation, you're going to have to do something to the price of government debt, which makes everything a lot trickier at a time when you know people are really focused on interest rate volatility. Yeah, all right, we should leave it there, because we could talk about this for another two hours probably. All right. This has been another episode of the All Thoughts podcast. I'm Tracy Alloway. You can follow me on

Twitter at Tracy Alloway and I'm Joey Isn't All. You can follow me on Twitter at the Stalwart. Be sure to follow our guest Toby Nangle He's at Toby Underscore. And follow our produce user of this episode, Dash Bedding, He's at Dashbot. And follow our other producer, Carmen Rodriguez at Carmen Armand. And if you're looking for even more discussion on the pound, guilt and everything else going on in the British economy, definitely check out In the City.

It's a new podcast from Bloomberg UK and it's toasted by Francine Lachlaw and David Merritt. It's covered all these finance stories straight from the heart of London. Thanks for listening.