Credit Collateralised Gilt Repo goes live!
Plus macro update: lies, damn lies and statistics
In Summary
- Credit Collateralised Gilt Repo (CCGR) is live, with BlackRock transacting the first trade in the market for a gilt repo that can have corporate bonds posted as collateral.
- This creates another important tool in the pension scheme armoury for managing collateral resilience and avoiding becoming a forced seller of corporate bonds during periods of market stress.
- With the Bank of England (BoE) closely watching a very mixed set of economic data, the timing and magnitude of expected cuts remains highly changeable while the upcoming budget is expected to confirm record net gilt issuance for 2024/2025, in value terms at least.
- Additional tools to increase resilience are key in an environment where the direction of yields remains deeply uncertain and two way.
Credit Collateralised Gilt Repo goes live!
As schemes continue to evolve their collateral resilience to market shocks and build out collateral waterfalls, BlackRock has partnered with brokers to develop new ways of enhancing collateral resilience. This has resulted in the development of a new solution in the repo market – Credit-Collateralised Gilt Repo (CCGR).
We are excited to announce that this market is now live, with BlackRock having completed the first trade on 19 February 2024 for one of our LDI clients.
CCGR involves entering a gilt repo to gain leveraged exposure to gilts within the LDI mandate, as is typical in LDI strategies, but with upfront agreement that the repo can be collateralised if a mark to market emerges due to movements in yields with a broader, pre-agreed range of collateral assets. This allows corporate bonds being held with BlackRock, for example in a buy and maintain mandate, to be posted as collateral against the gilt repo in a scenario where gilt yields increase. This increases the size of the collateral pool the pension scheme has available, boosting resilience.
Different approaches to repo
Source: BlackRock. Illustrative only.
What are the potential benefits of CCGR?
Both credit repo and CCGR can boost collateral resilience by expanding the collateral pool and allowing otherwise ineligible assets to contribute to the collateral buffer. BlackRock was able to deploy credit repo for clients with a segregated buy and maintain mandate in Autumn 2022 to avoid having to sell down assets. As we wrote about in our January 2024 update Credit where its due, this is a key focus given the potential downside risks of forced credit sales during a market downturn.
The key difference between using credit repo as and when you need it and running CCGR on an ongoing basis is that for CCGR the ability to post the credit if yields rise is built in. This contingent nature means that if yields do increase, then for the life of your remaining gilt repo positions implemented with this optionality to post credit, additional collateral capacity will be available. Using several staggered repo contracts allows for the management of roll risk and comfort that if a sudden shock occurs, the scheme can fall back on posting its credit without having to rely on accessing the credit repo market for new funding during what could be a volatile and uncertain period.
Collateral risks are managed using haircuts and limiting the rating, maturity and sector eligibility of corporate bonds. These haircuts may be higher than those experienced on a credit repo. The term of CCGR is also expected to be shorter than the maximum typically possible with gilt repo.
Source: BlackRock. Data as of February 2024. Illustrative only. Repo haircut represents the difference in value between the bond and cash amount, while collateral haircut represents the amount of additional collateral that must be posted when meeting variation margin requirements.
If you would like to discuss how this innovative approach could work for your scheme, please reach out to your usual BlackRock representative.
Macro Update: lies, damn lies and statistics
The UK economy received several key economic updates between the 13 and 15 February 2024, including labour market, inflation and GDP data. Alongside this the US also received an inflation print, which surprised somewhat to the upside.
The UK data presented a mixed picture, not helped by continuing challenges in the publication of UK labour market statistics and volatility in inflation weights making it difficult to separate the signal from the noise.
In labour markets the challenges faced by the Office for National Statistics (ONS) due to low responses to their Labour Force Survey (LFS) continued, with the full re-instatement of various statistics delayed until September 2024. The latest report for the statistics it did release was strong, with the unemployment rate dropping to 3.8%, vacancies still falling (albeit slower than many expected) and wage growth showing signs of ticking up with private sector regular pay increasing 6.2% Year on Year (YoY).
Vacancies are continuing to fall but still around 100k above pre-pandemic levels
Source: BlackRock, ONS. Data as at February 2024.
Some of these statistics may have been impacted by recent re-weightings of the population distribution made by the ONS, In addition to this, if we consider the changes in actual average wages earned on weekly basis as a monetary amount there are signs that after a rapid acceleration this measure has stabilised.
Average Weekly Earnings in Pound terms increased steadily over 2022 and H1 2023 but showed signs of levelling off towards the end of 2023
Source: BlackRock, ONS. Data as at February 2024.
Given some of the challenges with the LFS, many in the market are considering other sources and XpertHR have shown the wage settlements remain high, with median January wages increases dropping to 5.1% from 6% for the previous quarter. Overall the wage picture remains robust and this is likely not sufficient to allow Monetary Policy Committee members to become comfortable with cutting rates in the near term.
In inflation, the UK CPI print at 4.0% Year on Year provided some welcome news coming in below market consensus, but with some categories that the BoE are closely watching such as core services inflation ticking upwards to 6.5% the picture remains mixed. Again with inflation the challenges of trusting what statistics tell you on face value was evidenced by a large proportion of the drop being driven by transport and in particular airfares. Airfares increased rapidly in December before falling back significantly in January and between these two months the relative weights were reset, increasing the weights to airfares. Some of this effect may therefore unwind in the coming months.
Drilling down into the transport category of CPI shows how volatile and seasonal some categories can be
Source: BlackRock, Bloomberg. Data as at 23 February 2024.
The data busy week for the UK wrapped up with GDP growth showing the UK economy entering a technical recession over the second half of 2023. This is however a backward looking data point and there is evidence from surveys such as the Purchasing Managers Index (PMI) that the economy has entered 2024 on a firmer footing, with services PMI holding up at 54.3, well above the 50 level that indicates expansion.
But what does all this mean for interest rates?
The mixed picture presented by the data likely makes it difficult for the core of the Monetary Policy Committee (MPC) currently voting to hold rates to switch to cuts. With the lack of reliable labour market data from the Office for National Statistics (ONS), seemingly resilient wage growth and falling but still strong at its core inflation, the risk of cutting too soon and having to reverse is very real. Cuts will probably come later in the year but the timing and magnitude remain difficult to predict with the data volatility and there are still upside risks from the seemingly tight labour market.
This has been reflected in the volatility recently seen in short dated interest rate expectations as doves and hawks have played data induced ping pong with front end pricing of when cuts will start and how deep they will go this year.
Conflicting data releases continue to drive expectations for the speed and starting date of rate cuts
Forecasts may not come to pass. Source: BlackRock, Bloomberg. Data as at 26 February 2024.
There has also been much speculation on how much fiscal headroom the Chancellor will have to spend at the upcoming budget on 6 March 2024. To some extent this focus is irrelevant as in an election year, whatever headroom the Chancellor is granted by the Office for Budgetary Responsibility versus his fiscal rules is likely to be spent. The Debt Management Office may be able to offset the impact of expected record net gilt issuance for 2024/2025 by skewing issuance to shorter tenors – more on this as details are confirmed – but it will still be a lot for the market to absorb.
With this continuing uncertainty on the path of rates and the expectation of elevated levels of gilt supply, 30 year real yields have been holding up at just below 1.5%, off the peak levels reached in October 2023 but none the less elevated.
30yr real gilt yields remain close to recent highs despite expectations of interest rate cuts to come
Source: BlackRock, Bloomberg. Data as at 23 February 2024. Yield for 2052 Index-linked Gilt. The figures shown relate to past performance. Past performance is not a reliable indicator of current or future results.
With the market continuing to feel only another turn in the sometimes confounding data away from a further leg higher in yields, having additional tools in the armoury such as CCGR to help increase collateral resilience has never felt so important.
