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Repo rates are expressed relative to SONIA, and the chart below displays the average repo rates that we have achieved over the past four quarters for three, six, nine and 12-month repos, shown as a spread to average SONIA levels at the time. The volatility and market uncertainty that resulted from the mini-Budget also weighed upon funding markets, particularly for shorter dated trades as can be seen from the achieved spreads below. Note that during the fourth quarter of 2022 no repos were traded with a 12m tenor so the chart reflects the previous quarter’s value.
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Figure 2: Change in swap rates over the next quarter
The secondary impact of the mini-Budget crisis centred around collateral and the velocity of movement; rather than a lack of balance sheet for repo funding (a la March 2020). Yet, the difficulties around collateral substitutions and settlements did in many cases prompt a review by individual banks’ credit officers, resulting in a temporary reduction or hiatus in repo balance sheet provision in some cases. Once these reviews were completed balance sheet availability opened up again – some with the addition of haircuts to provide additional protection to the bank. Of course, the momentous lack of certainty in the future path of interest rates also impacted the typical repo spread to SONIA as trading a fixed rate forced the banks to take a conservative view on where yields could reach.
The funding ratio index published by the Pension Protection Fund showed a slight decrease in funding levels quarter-on-quarter (124.7% at end March vs 125.7% at end December). Higher yields benefitted the liability side of the equation, however the dramatic fall in equities weighed upon funding ratios. High hedging levels mean that schemes saw only a modest gain from the higher yields but still retain some exposure to equities.
Market Outlook
Source: Columbia Threadneedle Investments. As at 31 March 2025
Inflation hedging rose by 12% quarter on quarter, whilst interest rate hedging activity increased by 27% from the previous quarter.
All data and sources Columbia Threadneedle Management Limited, as at 30 June 2024 and Valid to: 30 September 2024
Regions
2025 started with a bang as Donald Trump – the 47th (and 45th) President of the United States embarked upon a whirlwind of executive orders designed to protect the US from the depredations of its trading partners and to dive straight into his newly mandated agenda.
As anticipated, (sometimes contradictory) news-flow came thick and fast, forcing the market to stay on its toes and boosting volatility. The difficulty of knowing where bluster and negotiation tactics fold into a desired end-game also provides a challenge to central banks, who are attempting to steward domestic economies through to a positive economic outcome.
An early January sell-off resulted in higher yields in the UK and called into question Chancellor Reeves’ newly minted (and stringent) fiscal rules. As yields rise, issuing government debt becomes more expensive, adding to borrowing costs and eroding the small buffer before the fiscal rules would be broken. This fear, exacerbated by the wall of issuance required to service the country’s roll-over of debt and spending commitments caused a downward spiral in sentiment, leading the UK to underperform Europe and the US. The initial move was sparked by global factors, but UK-centric debt and stagflation concerns magnified the impact. Fears that inflation would remain elevated, preventing the expected monetary policy rate cutting cycle dissipated as both the US and the UK surprised with much lower inflation outcomes than anticipated.
Once President Trump was inaugurated, the US dominated both the news-cycle and market developments leaving domestic concerns to take a back-seat – even though significant changes such as increases in defence spending and a relaxation of the debt brake in Germany could have been expected to make a bigger splash. Tariffs seemed top of President Trump’s wish list – an issue which he has expounded upon for many years, citing how other countries are taking advantage of the US. Many market participants downplayed the likely implementation of tariffs, focusing on his well-known desire for ‘deals’ and his previous term’s focus on the stock market. However, whilst some of the most shocking tariffs may indeed be a negotiating tactic, the ensuing uncertainty of what tariffs would be implemented and when (and how long they would last) served to put a dent in consumer confidence and all but halted capital expenditure and forward-looking hiring policies. The full-blown trade war focused in on China, with US tariffs reaching 145% and China retaliating at 125% – serving as a quasi-trade embargo. The impact is hard to ascertain whilst existing supplies last, but given the US’ reliance on imports, domestic US price increases and shortages are expected from May. The International Monetary Fund (IMF) significantly revised down global growth prospects as a consequence of both the higher level of tariffs and the uncertainty.
Total interest rate liability hedging activity increased to £34.4 billion, whilst inflation hedging fell slightly to £25.4 billion. Higher yields attracted outright hedging activity and volatility also provided opportunities to switch between hedging assets – sparked by US musings around relaxing leverage restrictions on banks. This would allow US banks to support more trading activity through an increase in balance sheet availability. The mere mention was sufficient to drive global asset swap spreads with the bond component becoming more expensive (reversing recent moves). One of the fears about UK susceptibility to global market moves is the UK’s reliance on overseas investors to buy government debt. The market dynamics have shifted over the past few years, resulting in lower demand from pension funds as they reach high hedging levels and even transition to buy-out. Insurance companies upon receiving a pension scheme’s assets would typically have sold the bonds to buy credit as it is higher yielding. However, credit spreads have been highly depressed and that has resulted in insurance companies holding excess allocations to government debt, either in physical or levered formats. There is a concern that more attractive credit yields could therefore unleash a wave of gilt sales from insurance companies. The Debt Management Office (DMO) has responded to these demand changes by reducing the volume of long dated gilts they issue (traditionally a market segment that is pension fund dominated) and increasing the unallocated bucket and short dated issuance.
Chart 1 below describes hedging transactions as an index based on risk. Note that transactions include switches from one hedging instrument into another. It should be noted that as the index is constructed by using the rate of change of risk traded by each counterparty per quarter, it allows the introduction (or removal) of counterparties in the survey.
Figure 1: Index of UK pension liability hedging activity (based on £ per 0.01% change in interest rates or RPI inflation expectations i.e. in risk terms).
Source: Columbia Threadneedle Investments. As at 31 March 2025
The funding ratio index published by the Pension Protection Fund showed a slight decrease in funding levels quarter-on-quarter (124.7% at end March vs 125.7% at end December). Higher yields benefitted the liability side of the equation, however the dramatic fall in equities weighed upon funding ratios. High hedging levels mean that schemes saw only a modest gain from the higher yields but still retain some exposure to equities.
Market Outlook
We also asked investment bank derivatives trading desks for their opinions on the likely direction of key rates for liability hedging. The aim is to get information from those closest to the market to aid investors in their decision-making.
The results are shown in Chart 2 below as the number of those predicting a rise less those predicting a fall, as a percentage of the number of responses. The larger the balance, the more responses predict a rise. The more negative the balance, the more responses predict a fall.
Figure 2: Change in swap rates over the next quarter.
Source: Columbia Threadneedle Investments. As at 31 March 2025
Last quarter our counterparties expected a fall in real and nominal yields but an increase in inflation (with low confidence). They were wrong on all three metrics. Tariffs were mentioned as a potential threat to their predictions but their hopes of the UK as a safe-haven were dashed as the UK displayed an alarming susceptibility to global moves.
By the mid-point of 2025 our counterparties are equally split on whether inflation could rise or fall due to the difficulty of estimating the impact of tariffs – some believe them to be disinflationary whereas others point to the inflation impact of higher costs on imports. There is strong conviction that both real and nominal yields should fall. The remit revision from the DMO went further than expected in reducing long-dated gilt issuance and the added flexibility over the May longs syndication (offering the potential for it to be revised to shorter dated gilt) shows an understanding of the concerns in the market regarding the demand profile. Tariffs can only be expected to be negative for the UK economy, but if there is an inflationary impact the hope is that the Bank of England (BoE) can look through it (define it to be transitory) and continue their rate cutting cycle. Depending on the near-term shock of tariffs on growth it may even persuade the BoE to cut more aggressively. Potential risks to this view centre around the instability of the fiscal rules and if the pledge to not raise taxes, national insurance or VAT holds then a further extension in issuance is likely to drive yields higher. The BoE also reacted to market pressures and volatility by postponing their long dated quantitative tightening programme gilt sales. Our counterparties muse as to whether there is further action they could take to support yields in the event of a negative spiral.
