Sero sapiunt Fhriges

October 2022 drew a hard line in the sand for UK gilts. Did they shut the stable door after the horse has bolted? Other countries now appear to be heading in the same direction.

In October 2022, the UK gilt market, long regarded as a symbol of stability and institutional reliability, crossed a line that few thought imaginable for a G7 sovereign issuer. A confluence of policy missteps and market fragilities led to a near-systemic event, shaking not only domestic confidence but also the foundations of the UK's credibility in global capital markets. The spark was political: then-Prime Minister Liz Truss unveiled a sweeping fiscal stimulus plan, centered on unfunded tax cuts and increased government spending, to be financed entirely through new debt issuance. Markets, already navigating a fragile post-pandemic macroeconomic environment, responded with ferocity. Long-dated UK government bonds, particularly the 30-year gilt, experienced a dramatic sell-off, with yields rising by nearly 250 basis points in a matter of days. This was not a rational repricing; it was disorderly and indiscriminate.

Liquidity in the gilt market evaporated. Bid-ask spreads widened dramatically, and at moments of peak stress, market participants could not close positions without absorbing substantial losses. What was unfolding was not simply volatility, but dysfunction. Beneath the surface, one of the pillars of the UK financial system, specifically, liability-driven investment (LDI) strategies used by pension funds, began to buckle. These strategies, reliant on leverage and typically long-duration in nature, were designed to match future liabilities through predictable cash flow instruments. But as gilt prices collapsed, pension funds faced margin calls on their hedging instruments, forcing them to sell their most liquid assets, which were, ironically, gilts themselves. These fire sales intensified the pressure on prices, creating a vicious feedback loop of selling, volatility, and further margin requirements.

This self-reinforcing dynamic quickly spread beyond pensions. Real money investors, such as insurers, asset managers, even banks, began to feel the tremors. Confidence was eroding not just in the fiscal trajectory of the UK, but in the very assumption that UK sovereign bonds could be relied upon in times of stress. The concept of a “bad equilibrium” moved from theory to reality.

The Bank of England was forced to act. In an extraordinary move, it announced a temporary but unlimited commitment to purchase long-dated gilts, explicitly citing the need to restore market functioning and preserve financial stability. The intervention worked. Market conditions stabilized, yields retreated from their extremes, and the immediate threat of a systemic crisis was averted. Yet the episode left deep scars.

In the months and years that followed, the upward drift in long-term gilt yields did not fully reverse. While part of that can be attributed to global inflation dynamics and shifting monetary policy expectations, a more structural factor was also at play: the erosion of trust. The UK had committed a cardinal sin in financial markets: it had undermined the perception of fiscal prudence and institutional coherence that anchors investor confidence. The cost of that mistake was visible not only in asset prices, but in reputational capital. Perhaps nothing captured this loss more sharply than a Bloomberg headline suggesting that the UK was on the verge of being treated like an emerging market.

The lesson is sobering. Central banks and policymakers, when highly competent and reactive, can stop financial fires from spreading. They can intervene decisively, and they can calm markets. But credibility, unlike liquidity, cannot be injected on demand. Once questioned, it does not return easily. The memory of market dysfunction lingers in risk models, in investor presentations, in asset allocation decisions made in boardrooms across the world. The sensitivity to political signals becomes heightened. Risk premia increase. And slowly, almost imperceptibly, the status of a sovereign issuer begins to change.

The October 2022 gilt episode was not just a moment of poor judgment. It was a hinge in the perception of UK macro-policy. A reminder that even in mature, developed markets, institutional capital is conditional. The credibility that took decades to build can, under the wrong conditions, begin to fray in days. And once the veil of reliability is pierced, it is exceedingly difficult to stitch back together.

Cave lineam rubram