Up next in 10
The Chancellor may have avoided a messy bond market reaction to her Budget, for now, but there’s something else lurking in the deep waters of government debt that has Bank of England officials worried: hedge funds.
In this episode of Week in Business, City AM Editor-in-Chief Christian May discusses the issues keeping the Bank of England governor up at night.
#business #economy #labour #politics #uk #news
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0:00
What keeps you up at night? For the
0:01
governor of the Bank of England, it's a
0:03
long list of threats to the UK's
0:05
financial system. So, let's take a look
0:07
at them. Welcome to the week in business
0:09
with me, Christian May.
0:14
The Bank of England's latest financial
0:16
stability report makes for a sobering
0:18
read. It says risks to financial
0:20
stability have increased during 2025 and
0:23
that global risks remain elevated and
0:25
material uncertainty in the global
0:27
macroeconomic outlook persists. So what
0:30
are these threats? Well, the chancellor
0:32
may have avoided a messy bond market
0:34
reaction to her budget for now, but
0:36
there's something else lurking in the
0:37
deep waters of government debt that has
0:40
Bank of England officials worried. Hedge
0:42
funds, specifically leverage trading in
0:44
the guilt repo markets. What's that?
0:47
Well, simply put, this refers to the
0:49
practice of hedge funds and other asset
0:50
managers arranging short-term loans
0:52
using their holdings of UK government
0:55
debt as collateral. And hedge funds, in
0:57
fact, a small number of US hedge funds
0:59
have increasingly taken out enormous
1:01
bets on small price fluctuations in the
1:04
UK bond market, which they then borrow
1:06
against and reinvest to boost their
1:08
returns. The arrangement appears to suit
1:10
all parties, as government debt is seen
1:12
as a safe bet. However, the Bank of
1:14
England is worried about what would
1:15
happen if those hedge funds suddenly
1:17
needed cash in response to a shock
1:19
elsewhere and had to liquidate their
1:21
holdings of UK bonds. As the Bank puts
1:24
it, forced or widespread deleveraging
1:26
would have the result of amplifying
1:28
initial moves and potentially triggering
1:30
a feedback loop or further forced
1:32
selling. They warned that the world is a
1:35
dangerous place and that there are
1:36
plenty of possible shocks in the future
1:38
that could force a fire sale of UK debt
1:40
that in turn could cause havoc in the
1:42
bond markets, forcing up the cost of
1:45
borrowing. The amount of debt taken out
1:47
against UK guilts has reached its
1:49
highest level since the central bank
1:51
started monitoring the trend in 2017.
1:53
Hedge funds used their guilt portfolios
1:55
to borrow some 100 billion pounds of
1:58
extra cash in November, a pattern of
2:00
behavior the bank said increases the
2:02
risk of sharp moves in the UK bond
2:05
market. Officials are so worried about
2:07
this that they're now exploring plans to
2:09
limit the size of hedge fund bets on
2:12
guilt in a bid to avoid the worst of any
2:14
future market fallout. Next up, growing
2:17
concerns about so-called shadow banking,
2:19
private credit. Now, this refers to
2:21
lending and financing by financial
2:23
institutions that are not banks. A
2:26
business could get a loan from HSBC or
2:28
Barclays, or it could get that loan from
2:30
a private debt fund or an asset manager
2:32
like Blackstone or Apollo, or even just
2:34
the private credit wing of banks. Now,
2:36
watchd dogs across the world have become
2:38
increasingly worried about the rather
2:40
opaque role that private markets play in
2:43
the global financial system after a
2:45
string of high-profile corporate
2:46
collapses in America with ties to
2:49
private lending. And these shadow banks
2:51
are not regulated like traditional
2:53
lenders. The International Monetary Fund
2:55
devoted a chapter of its own 2024
2:58
financial stability report to the
3:00
systemic threat posed by the private
3:02
credit industry, which now boasts an
3:04
estimated $2 trillion under management.
3:06
Now, Andrew Bailey has also compared
3:09
some of the riskier lending issued by
3:11
industry players to the subprime
3:13
mortgage crash that foreshadowed the
3:15
2008 financial crisis, and he says alarm
3:18
bells are ringing. Officials warned that
3:20
UK banks are estimated to have over 170
3:22
billion pounds of banking book exposure
3:25
to private market funds. So what are
3:28
they doing about this? Well, they're
3:29
going to start subjecting private credit
3:31
providers to the same kind of stress
3:32
tests applied to traditional banks where
3:34
they're required to demonstrate their
3:36
resilience to a range of hypothetical
3:38
risks and shocks to see if they could
3:40
withstand them. Another area of concern
3:43
reiterated by the Bank of England is
3:45
runaway valuations of AI companies and
3:47
the risk of a stock market bubble
3:50
bursting. They said many equities remain
3:52
materially stretched and drew
3:54
comparisons to the dotcom bubble and the
3:56
global financial crisis. The report
3:59
warns of the risks of a sharp correction
4:01
in the sector and of the various ways in
4:03
which the UK economy and UK market is
4:05
exposed to that risk. They say as an
4:08
open economy with a large financial
4:10
center, the UK is exposed to global
4:12
shocks that could transmit through
4:14
multiple interconnected channels. It
4:16
also gave a stark warning on the role
4:18
debt financing is playing in the AI
4:20
sector. And another cheerful note here,
4:23
the bank said that cyber attacks remain
4:25
a critical threat to financial
4:27
stability. Andrew Bailey said it's a
4:28
risk that never goes away and that you
4:31
can't mitigate cyber risk in a way that
4:33
just takes it off the table. The report
4:35
highlighted recent attacks on retailers
4:37
and car makers aka M&S and Jaguar Land
4:40
Rover and warned of bad actors out there
4:42
in the world economy. So from
4:45
vulnerabilities in the bond market to a
4:47
booming and lightly regulated private
4:49
credit industry to rogue states and
4:51
cyber attackers, the risks are real and
4:53
they're growing and getting more
4:55
complicated. Fortunately, being alive to
4:57
these risks is a full-time job for lots
4:59
of people and it's the first line of
5:00
defense. question as we approach the end
5:02
of this year is whether anything happens
5:04
next year that turns these risks into
5:07
active threats. Finally, I should point
5:09
out another critical risk to our
5:11
stability, our wealth, and our
5:12
well-being. That would be this
5:14
government. The consultancy Oxford
5:16
Economics this morning released its own
5:18
key themes for 2026 document. And it's
5:20
not pretty. They forecast a growth rate
5:23
of just 1% next year. Abysmal. and they
5:26
expect that markets will increasingly
5:28
question the fiscal credibility of the
5:30
budget and the survival of the labor
5:31
leadership. Adding a slow burn of a
5:34
steepening yield curve and weaker
5:36
sterling could morph into a more serious
5:38
confidence crisis, a risk heightened by
5:40
the fact that the UK lacks a sustainable
5:42
growth driver, meaning that prospects
5:44
for the private sector remain poor.
5:46
Consumers face a sharp slowdown in real
5:49
income growth next year and the jobless
5:51
rate will rise further. Okay, I don't
5:55
really have any positive note to end on
5:56
this week, but at least we didn't just
5:58
talk about the budget. Anyway, that is
6:00
it from me this week. Stay up to date
6:02
and in the know with the City AM app and
6:04
on cityam.com, and I will see you next
6:07
week for what will probably be the last
6:09
week in business of the year. So, I'll
6:11
see you then.
6:16
[Music]
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