市場分析

UK Debt Market Faces New Risks as Hedge Funds Take Larger Share

Amos Simanungkalit · 21 Mar88.7K 閱讀

Image Credit: Reuters

Hedge funds are increasingly engaging in debt-fueled bets on UK government bonds, raising concerns about potential instability in the gilts market, a key indicator for UK borrowing costs such as mortgages. According to investors and hedge fund sources, this surge in hedge fund activity is largely due to their use of short-term lending markets.

Bank of England chief Andrew Bailey had warned in February that hedge funds, along with other non-bank institutions, can exacerbate liquidity stress in core UK markets like the gilt market. Hedge funds account for a significant portion of the UK government bond market, with data from Tradeweb showing that in January and February, they were responsible for 60% of trading volumes in 10-year gilts, up from 53% in late 2023 and marking a five-year high.

David Aspell, senior portfolio manager at Mount Lucas Management, stated that the presence of large hedge funds can lead to chaotic trading in UK rates markets, where there is often less "real money" compared to hedge fund positions. While the UK gilts market is much smaller than the US Treasury bond market, volatility in these bonds can affect government borrowing costs and financial conditions for businesses and households.

Hedge funds have become more active in European bond markets, and while they may help provide liquidity, UK regulators are closely monitoring their use of repo markets for gilt positions. Repo, or repurchase agreements, are critical sources of short-term funding and can become vital during market stress. Hedge funds such as Brevan Howard, Capula Investment Management, and Millennium Management use repo financing to place various bets on gilts.

Currently, hedge funds are making three primary bets against UK government bonds: one involving shorting the basis trade, another speculating on sustained inflation, and a third on trends predicting a decline in 10-year gilt prices. These bets, though only part of hedge funds’ larger portfolios, collectively raise concerns about their potential impact on the gilt market. Hedge funds are taking up a disproportionate share of the UK repo market to finance these positions.

While some argue that hedge funds improve market liquidity and efficiency, others warn that their rising share of repo borrowing could deprive other institutions of funding, especially in times of market volatility. Pension funds, which rely on repo markets to finance hedging positions, are particularly vulnerable to gilt selloffs. As bond yields rise, pension funds may be forced to post more collateral, leading to fire sales that accelerate the market downturn.

To mitigate these risks, the Bank of England has introduced a new liquidity facility for gilt holders like insurance companies and large pension funds. This facility requires institutions to hold at least 2 billion pounds worth of UK bonds. The release of official growth and borrowing forecasts on March 26 is expected to be a critical test for market sentiment.

James Athey, a fixed-income manager, warned that rapid unwinds of hedge fund positions in the event of a market shock could amplify volatility and pose stability risks.