The decline in the Virtus Private Credit Strategy ETF has accelerated, down 17.47% YTD. Private equity was able to ride out the first stage of the bear market well: but a reckoning in private equity looms. Public pension funds in the US have already suffered big losses in 2022 but have yet to factor in second-quarter returns on private equity and other illiquid investments.
Collateral calls in LDI derivative trades have amplified market moves. In March 2020, the BoE and the Fed moved quickly to damp bond market selloffs and ease the ‘dash for cash’. This time, they are powerless to intervene. Bond yields have risen by much more than the standard stress-test scenario (a 1.5 percentage point rise in long-term gilt yields).
The entirety of the UK instantaneous implied real forward curve (gilts) has now shifted into positive territory. US real yields have now risen above 1.5% across the curve. Higher real yields reflect the increased fiscal risks facing governments. This is clear in cases such as the UK. But US government real bond yields have also spiked.
The UK experience may have shaken markets’ confidence that real yields will remain low indefinitely. Given the record levels of government debt globally, the ‘normalisation’ in bond yields has heaped huge pressure on public finances. The public finances of many major developed economies were on unsustainable paths even before the recent spike in yields.
The credibility of the Bank of England has been undermined by the slow pace of interest rate hikes. Carrying on with a bloated balance sheet, not embarking on QT, would send sterling down lower, and widen the ‘theoretical losses’ on the APF. Ultimately, there is no easy way out, other than a tight fiscal policy. Japan faces the same, if not more acute, challenges.
