Sive Morten
Special Consultant to the FPA
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Fundamentals
Guys, we have so many important information that I would like to share with you that I'm a bit confused on how to cover it. If I put it here, in weekly report - you will not read it, as it is too big. Maybe it makes sense to start daily audio/video communique for 3-5 minutes to cover it. It is of different spheres - economy, rumors, politics etc. But all these stuff is vital to see the picture in a whole. For example, things that we see on UK bond market is an example what we soon should see in Japan and the US. Besides, we do not know the whole truth, information is hidden and becomes public only partially, when it is impossible to hide any more.
At the same time, ongoing economical processes is a reflection of big geopolitical game now that should shape the world geopolitical picture in near term. We will discuss it tomorrow in our Gold market report. With the big political games it now becomes clear why Russia has taken pause in military operation in summer and why Middle East relation to the US has changed. This makes coming shifts more or less clear, at least direction of them...
Markets overview
Wall Street stocks closed sharply lower on Friday as investors worried about inflation and rising interest rates while the dollar rose against the yen and sterling after the British prime minister's firing of her finance minister. Sterling fell sharply after Britain's Liz Truss fired finance chief Kwasi Kwarteng and scrapped parts of their economic package, which had caused an uproar in financial markets. The dollar also kept rising against Japan's beleaguered yen, hitting a fresh 32-year peak of 148.86.
Oil settled sharply lower as recession concerns translated to worries about demand.
In U.S. Treasuries, benchmark 10-year yields gained some ground after data showed U.S. retail sales were unexpectedly flat in September as high inflation crimped demand and investors continued to bet on aggressive Federal Reserve rate hikes. While traders stepped in to cover bearish bets on Thursday despite higher-than-expected inflation data, Mahajan noted that stocks headed lower on Friday after a University of Michigan survey showed rising inflation expectations:
Friday was expected to be the last day of the Bank of England's bond buying program set up to stabilize government bond, or gilt markets, after investors were spooked by unfunded tax cuts announced in a "mini-budget" last month. Investors appeared to have little confidence in the prime minister's position or the likelihood that her decisions on Friday could restore Britain's credibility in financial markets.
Japanese Finance Minister Shunichi Suzuki on Thursday reiterated the government's readiness to take steps against excessive currency volatility.
In U.S. Treasuries, yields edged higher as investors continued to digest Thursday's red-hot U.S. inflation print and contemplated interest rates staying higher for longer with the Fed's policy rate potential moving closer to 5%.
UK Bond market crush
You, probably, know in general what was the reason of yields collapse, as we've discussed it last week. The Bank of England has been forced into emergency bond-buying to stem a sharp sell-off in Britain's 2.1 trillion pound ($2.3 trillion) government bond market that threatens to wreak havoc in the pension industry and increase recession risks. The sell-off began after Kwarteng's tax-cut announcement. Formally it is LDI tool to finance short-term liquidity demand by pension funds and other Gilts holders. LDI assets quadrupled in a decade to 1.6 trillion pounds ($1.79 trillion) last year. Nearly two-thirds of Britain's defined benefit pension schemes use LDI funds, according to TPR.
In an attempt to appease financial markets that have been in turmoil for three weeks, Truss fired Kwasi Kwarteng as her chancellor of the exchequer on Friday and scrapped parts of their controversial economic package. In a hurried news conference shortly after dismissing Kwarteng, Truss said the corporation tax rate would increase, abandoning her plan to keep it at current levels, and government spending would rise by less than previously planned.
Kwarteng's Sept. 23 fiscal statement prompted a backlash in financial markets that was so ferocious that the Bank of England had to intervene to prevent pension funds being caught up in the chaos as borrowing costs surged. Hunt said he agreed with Truss's fundamental approach of seeking to spark economic growth but the way she and Kwarteng went about it had not worked.
Truss was due to spend the weekend trying to shore up her flagging support within the Conservative Party, with newspapers quoting lawmakers who questioned her ability to stay in the job. On Monday, the British government bond market faces a test when it will function for the first time without the emergency buying support provided by the BoE since Sept. 28. Gilt prices fell sharply late on Friday after Truss's news conference.
Chart of 30 year Gilts shows that BoE supportive measures haven't calmed down market, as it returns back to 5% after minor drop when BoE buyback strategy has been announced. Despite daily 5 Bln pounds (later it has increased to 10 Bln) demand the yield has not turned down. What should happen on Monday, as BoE demand is off...
Andrew Bailey dashed the hopes of pension funds on Tuesday, ruling out continuing the Bank of England’s £65bn bond-buying intervention into next week. The BoE governor said that although strains had been felt, market conditions in the government bonds “seemed calmer” on Tuesday after it had staged its second emergency intervention in two days. “We’ve announced we will be out by the end of this week. ... “We would not be surprised if the bank had to extend its pledge to buy gilts beyond Friday, 14th October.” “Two interventions in 24 hours is pretty extraordinary,” said Sandra Holdsworth, UK head of rates at Aegon Asset Management, adding that the BoE’s steps showed how the problem in the pensions industry was “much bigger than anyone thought a week ago”
The total yield of UK Gilt long-term bonds since December 2021 was -52.3%. A whole decade of profit has been wiped out. And yes - there are loss not for just 200 Bln as they told us:
Panic buying of bullion? About being out of reach. People are trying in a panic to exchange a Pound wrapper for Gold or Silver bars, but as we can see, even their Owners do not need a Pound Wrapper. The Central Bank's main weapon is not quantitative easing or setting interest rates. This is authenticity that they are losing.
The gyrations in bonds are at the center of wider turbulence across sterling assets. UK mortgage rates are soaring and investors are rushing to exit property funds.
Kwarteng approved the purchase of long-dated gilts up to £100 billion, according to a letter from Kwarteng to Mel Stride, a member of Parliament who leads the Treasury Committee.
The higher amount wasn't mentioned last week when the BoE restarted QE in a "temporary and targeted" bond buying operation - which will be as "temporary" as "temporary" inflation was - warning of a "material risk to UK financial stability" if the turmoil in the UK government bond market were to continue. It also raised the prospect of a "tightening of financing conditions and a reduction of the flow of credit to the real economy," but it really meant that QT was over before it even started, and QE is back. It looks like direct confrontation of BoE and the Government.
Coming 21 days could be vital for UK bond market. What will happen on Monday, as the Bank of England stops supporting government bonds - drop the value of securities and an yields increase spiral? The next blow to the market is on October 31. The Bank of England will begin to reduce liquidity (QT). The most serious attack will be launched on November 3. The Bank of England at the meeting will sharply raise the rate to at least 2.75%. Earlier on November 2, the Fed will sharply raise the rate as well... Buy popcorn, guys.
Here are few additional topics that stand around it:
Analysis: British banks' mortgage payday comes with sting in the tail
BoE should extend bond buying to Oct 31 or "possibly beyond"-pensions trade body
Bank of England warns mortgage defaults to rise in months ahead
Britain needs to restore stability to its finances to help reverse the fastest drop in financial sector sentiment in three years, a survey by business body CBI and consultants PwC said on Thursday. Sentiment in the third quarter to September fell at its fastest pace since September 2019, when it was hit by uncertainty around Brexit negotiations, the survey said.
Kwarteng becomes Britain's shortest serving finance minister except for a predecessor who died suddenly in office in 1970. "You have asked me to stand aside as your Chancellor. I have accepted," he wrote in his resignation letter to Truss. Truss's own position is now in jeopardy.
She won the Conservative Party leadership last month by promising vast tax cuts and deregulation that she said would shock the economy out of years of stagnant growth. Kwarteng's Sept. 23 fiscal announcement aimed to deliver that vision. Compounding the market pressures, polls show support for the Conservative Party has collapsed, fuelling panic in Britain's dominant political party and a hunt to find a way to force Truss out of office.
So, it is painful choice - either to keep struggling inflation, rising yields and coming to QT, or... support bond market, pension fund system and start printing money, pushing inflation to the sky. Something tells me, that whatever scenario will be chosen, the 0.95 our GBP target will be reached. It is just a question of time.
The US starts to mirror UK bond market
What we've said about UK bond market - 2.7 Trln? Would you heard about ten times greater market and that it start getting the same problems.
Markets now are interested not in inflation level, but in the trajectory of tightening the Fed's monetary policy. Just a week ago, market expectations regarding the rate after the Fed meeting on November 2 were in the following proportion: 25% chances for 3.75% (an increase of 0.5 percentage points from the current rate) and 75% chances for 4% (an increase of 0.75%).
Now expectations shifted sharply to the rate of 4% with a probability of 99% and a 1% increase to 4.25%. More fierce expectations regarding the Fed meeting on December 14. Now the rate of 4.5% has a probability of 37% and 4.75% - 62%. Just within a week, the probability of a rate of 4.75% has shifted from 7% to 62%!
In the dollar zone, rates around 5% is an absolutely crazy stuff! As a result, bonds collapsed.
Few months ago we've mentioned that US Treasury market liquidity is melting. New US Treasury issues just can't find the buyers, except, maybe, official dealers. Now this problem has official confirmation. Liquidity evaporates quickly. The volatility is off the scale. Once unthinkable, even the demand for government debt auctions is becoming a problem. Conditions are so worrisome that Treasury Secretary Janet Yellen took the unusual step on Wednesday of expressing concern about a potential trade disruption, saying after a speech in Washington that her ministry was "concerned about the loss of adequate liquidity" in the $23.7 trillion U.S. market. government securities. Make no mistake, if the Treasury bond market stops, the global economy and financial system will have much more serious problems than increased inflation.
The U.S. Treasury Department is asking primary dealers of U.S. Treasuries whether the government should buy back some of its bonds to improve liquidity in the $24 trillion market. Liquidity in the world's largest bond market has deteriorated this year partly because of rising volatility as the Federal Reserve rapidly raises interest rates to bring down inflation.
Indeed, as we've said, it is big problems with demand. Former major foreign buyers, such as China, Middle East countries, Russia and some others have become a net sellers due political confrontation, while EU, Japan, UK just have no free cash flows to invest in US bonds because of record high trade and current account deficits. The only resource that Fed has is inner one, but where to get enough funds to support 24 Trln market? Only interest payment for 31 Trln national debt stands for ~ 0.6 Trln. While the budget deficit is at record high of $1.14 Trln:
At the moment, there are no special buyers in US bonds. Everyone is staying away from this market now - from Japanese pension funds and insurers (Japan is the largest whale in US bonds) to foreign governments and US commercial banks. Demand in bonds has fallen sharply as the Fed reduces the balance sheet (QT) The US bond market has demonstrated a record-breaking decline in the history of the year, the volatility in the market has also increased to record values:
But this is not all yet. Fed Reserve just can't keep QT pace and can't sell off 8.9 Trln balance sheet, just because it earned less on its assets than it has paid for them. Fed reports loss on its operations this year within a decade. It seems that QT might be over before 2023 starts. The Federal Reserve is posting its first operating loss in years as interest rates soar and demand for US bonds craters. Fed data show the central bank reporting earnings remittances due to the US Treasury of negative $2.9 billion as of Oct. 5.
Now by the way, exactly the period of banks earnings reports and majority of them are primary US Treasury dealers. Whether banks have ability to help US Treasury to support liquidity. And, in general, what doesn it mean to "provide liquidity"? It means that commercial banks have to buy government bonds with real negative interest rates, increasing their loss after adjustment to inflation. Once you have bought the bond - you immediately start paying for it. Meantime, recent US banks reports are not very good:
Morgan Stanley profit misses estimate as deals drought extends
Wells Fargo profit falls on sales scandal costs, higher reserves
JPMorgan profit beats estimates on gains from higher interest rates
Citigroup beats profit estimates as rate hikes bolster lending business
JPMorgan, Citigroup say higher capital requirements may hurt lending
Loss provisions gradually are rising, additionally, profit margin on long-term products becomes tighter as banks have to keep low rates on long-term loans while to fund them with higher current rate. JPMorgan Chase & Co Chief Executive Officer Jamie Dimon on Thursday warned that persistent and elevated inflation could spur interest rates to rise higher than 4.5%, as he cautioned about the possibility of a looming recession.
Meantime, winter will cost US households 28% more than a year ago, according to the US Department of Energy. Very bad data for the US stock market. Inflation in the US in winter may be very high, despite the tightening of the Fed rate. At the same time, core inflation will also be high, largely due to high rental prices. It seems that the world economy is in a "perfect storm" situation.
In General bond market by far already shows 4th worst ever performance:
Conclusion:
It seems guys, that crisis processes are accelerating and is ready to get out of control. All major central banks meet the same problems either to spin up inflation or to crush the domestic bond market. UK is a most bright example, Japan should follow next, while Fed is showing the same problems but they look smooth as they have more or less but significant reserve to drive it by far. EU market meets the same problems very soon. They could be even stronger due to more complex political and economical structure of the union.
Things that we see in the news are just the top of the iceberg. Problems probably are much greater but they stand in secret and turns public when it becomes impossible to hide them any more. Now we do not see any reasons to change our long-term targets on EUR (0.9) and GBP (0.95). For EUR perspectives might be even worse due to political situation. We will explain it in our Gold market report tomorrow.
Any bounce on EUR, GBP or any other currencies seem to be temporal. Fed is aimed on inflation fighting, at least in near term, which should keep strong pressure on all existed rivals. Until elections on 8th of November, Fed could let markets to show rallies, mostly as by product of stock market support. Democrats need to make the image of prosperity and improvements. So they could support stocks for few weeks, to calm down people a bit. At least historically, stock market always rises at the eve of election day. Once elections passed, everything should back to its own. So, do not be deceived with this trap.
Guys, we have so many important information that I would like to share with you that I'm a bit confused on how to cover it. If I put it here, in weekly report - you will not read it, as it is too big. Maybe it makes sense to start daily audio/video communique for 3-5 minutes to cover it. It is of different spheres - economy, rumors, politics etc. But all these stuff is vital to see the picture in a whole. For example, things that we see on UK bond market is an example what we soon should see in Japan and the US. Besides, we do not know the whole truth, information is hidden and becomes public only partially, when it is impossible to hide any more.
At the same time, ongoing economical processes is a reflection of big geopolitical game now that should shape the world geopolitical picture in near term. We will discuss it tomorrow in our Gold market report. With the big political games it now becomes clear why Russia has taken pause in military operation in summer and why Middle East relation to the US has changed. This makes coming shifts more or less clear, at least direction of them...
Markets overview
Wall Street stocks closed sharply lower on Friday as investors worried about inflation and rising interest rates while the dollar rose against the yen and sterling after the British prime minister's firing of her finance minister. Sterling fell sharply after Britain's Liz Truss fired finance chief Kwasi Kwarteng and scrapped parts of their economic package, which had caused an uproar in financial markets. The dollar also kept rising against Japan's beleaguered yen, hitting a fresh 32-year peak of 148.86.
Oil settled sharply lower as recession concerns translated to worries about demand.
In U.S. Treasuries, benchmark 10-year yields gained some ground after data showed U.S. retail sales were unexpectedly flat in September as high inflation crimped demand and investors continued to bet on aggressive Federal Reserve rate hikes. While traders stepped in to cover bearish bets on Thursday despite higher-than-expected inflation data, Mahajan noted that stocks headed lower on Friday after a University of Michigan survey showed rising inflation expectations:
"We're back to looking at inflation data very carefully. The Fed does watch inflation expectations. They certainly don't want inflation expectations to become ingrained in consumer sentiment," said Mahajan, who also noted signs of fear in the market as the CBOE Volatility index (.VIX) remained above 30.
Friday was expected to be the last day of the Bank of England's bond buying program set up to stabilize government bond, or gilt markets, after investors were spooked by unfunded tax cuts announced in a "mini-budget" last month. Investors appeared to have little confidence in the prime minister's position or the likelihood that her decisions on Friday could restore Britain's credibility in financial markets.
Japanese Finance Minister Shunichi Suzuki on Thursday reiterated the government's readiness to take steps against excessive currency volatility.
In U.S. Treasuries, yields edged higher as investors continued to digest Thursday's red-hot U.S. inflation print and contemplated interest rates staying higher for longer with the Fed's policy rate potential moving closer to 5%.
UK Bond market crush
You, probably, know in general what was the reason of yields collapse, as we've discussed it last week. The Bank of England has been forced into emergency bond-buying to stem a sharp sell-off in Britain's 2.1 trillion pound ($2.3 trillion) government bond market that threatens to wreak havoc in the pension industry and increase recession risks. The sell-off began after Kwarteng's tax-cut announcement. Formally it is LDI tool to finance short-term liquidity demand by pension funds and other Gilts holders. LDI assets quadrupled in a decade to 1.6 trillion pounds ($1.79 trillion) last year. Nearly two-thirds of Britain's defined benefit pension schemes use LDI funds, according to TPR.
In an attempt to appease financial markets that have been in turmoil for three weeks, Truss fired Kwasi Kwarteng as her chancellor of the exchequer on Friday and scrapped parts of their controversial economic package. In a hurried news conference shortly after dismissing Kwarteng, Truss said the corporation tax rate would increase, abandoning her plan to keep it at current levels, and government spending would rise by less than previously planned.
Kwarteng's Sept. 23 fiscal statement prompted a backlash in financial markets that was so ferocious that the Bank of England had to intervene to prevent pension funds being caught up in the chaos as borrowing costs surged. Hunt said he agreed with Truss's fundamental approach of seeking to spark economic growth but the way she and Kwarteng went about it had not worked.
"There were mistakes. It was a mistake when we're going to be asking for difficult decisions across the board on tax and spending to cut the rate of tax paid by the very wealthiest," he said. It was a mistake to fly blind and to do these forecasts without giving people the confidence of the Office of Budget Responsibility saying that the sums add up. The Prime Minister has recognised that, that's why I'm here."
Truss was due to spend the weekend trying to shore up her flagging support within the Conservative Party, with newspapers quoting lawmakers who questioned her ability to stay in the job. On Monday, the British government bond market faces a test when it will function for the first time without the emergency buying support provided by the BoE since Sept. 28. Gilt prices fell sharply late on Friday after Truss's news conference.
Chart of 30 year Gilts shows that BoE supportive measures haven't calmed down market, as it returns back to 5% after minor drop when BoE buyback strategy has been announced. Despite daily 5 Bln pounds (later it has increased to 10 Bln) demand the yield has not turned down. What should happen on Monday, as BoE demand is off...
Andrew Bailey dashed the hopes of pension funds on Tuesday, ruling out continuing the Bank of England’s £65bn bond-buying intervention into next week. The BoE governor said that although strains had been felt, market conditions in the government bonds “seemed calmer” on Tuesday after it had staged its second emergency intervention in two days. “We’ve announced we will be out by the end of this week. ... “We would not be surprised if the bank had to extend its pledge to buy gilts beyond Friday, 14th October.” “Two interventions in 24 hours is pretty extraordinary,” said Sandra Holdsworth, UK head of rates at Aegon Asset Management, adding that the BoE’s steps showed how the problem in the pensions industry was “much bigger than anyone thought a week ago”
The total yield of UK Gilt long-term bonds since December 2021 was -52.3%. A whole decade of profit has been wiped out. And yes - there are loss not for just 200 Bln as they told us:
Panic buying of bullion? About being out of reach. People are trying in a panic to exchange a Pound wrapper for Gold or Silver bars, but as we can see, even their Owners do not need a Pound Wrapper. The Central Bank's main weapon is not quantitative easing or setting interest rates. This is authenticity that they are losing.
The gyrations in bonds are at the center of wider turbulence across sterling assets. UK mortgage rates are soaring and investors are rushing to exit property funds.
“Bailey’s words did sound harsh but from the BOE’s perspective they need to sound stern,” said Pooja Kumra, rates strategist at Toronto-Dominion Bank. “The BOE has been very receptive to markets. If chaos continues we doubt that they will run away.”
Kwarteng approved the purchase of long-dated gilts up to £100 billion, according to a letter from Kwarteng to Mel Stride, a member of Parliament who leads the Treasury Committee.
"The Bank has requested an extension to the maximum size of the APF by £100 billion to £966 billion," the Chancellor wrote in a letter dated published on Friday. "There was a special urgency to incur this liability."
The higher amount wasn't mentioned last week when the BoE restarted QE in a "temporary and targeted" bond buying operation - which will be as "temporary" as "temporary" inflation was - warning of a "material risk to UK financial stability" if the turmoil in the UK government bond market were to continue. It also raised the prospect of a "tightening of financing conditions and a reduction of the flow of credit to the real economy," but it really meant that QT was over before it even started, and QE is back. It looks like direct confrontation of BoE and the Government.
Coming 21 days could be vital for UK bond market. What will happen on Monday, as the Bank of England stops supporting government bonds - drop the value of securities and an yields increase spiral? The next blow to the market is on October 31. The Bank of England will begin to reduce liquidity (QT). The most serious attack will be launched on November 3. The Bank of England at the meeting will sharply raise the rate to at least 2.75%. Earlier on November 2, the Fed will sharply raise the rate as well... Buy popcorn, guys.
Here are few additional topics that stand around it:
Analysis: British banks' mortgage payday comes with sting in the tail
BoE should extend bond buying to Oct 31 or "possibly beyond"-pensions trade body
Bank of England warns mortgage defaults to rise in months ahead
Craig Inches, head of rates and cash at Royal London Asset Management, said: "To a global investor the UK looks a mess and therefore global investors don't want to step in and buy yields at attractive levels until the UK gets its house in order."
Britain needs to restore stability to its finances to help reverse the fastest drop in financial sector sentiment in three years, a survey by business body CBI and consultants PwC said on Thursday. Sentiment in the third quarter to September fell at its fastest pace since September 2019, when it was hit by uncertainty around Brexit negotiations, the survey said.
Kwarteng becomes Britain's shortest serving finance minister except for a predecessor who died suddenly in office in 1970. "You have asked me to stand aside as your Chancellor. I have accepted," he wrote in his resignation letter to Truss. Truss's own position is now in jeopardy.
She won the Conservative Party leadership last month by promising vast tax cuts and deregulation that she said would shock the economy out of years of stagnant growth. Kwarteng's Sept. 23 fiscal announcement aimed to deliver that vision. Compounding the market pressures, polls show support for the Conservative Party has collapsed, fuelling panic in Britain's dominant political party and a hunt to find a way to force Truss out of office.
"She's toast," one party lawmaker said.
So, it is painful choice - either to keep struggling inflation, rising yields and coming to QT, or... support bond market, pension fund system and start printing money, pushing inflation to the sky. Something tells me, that whatever scenario will be chosen, the 0.95 our GBP target will be reached. It is just a question of time.
The US starts to mirror UK bond market
What we've said about UK bond market - 2.7 Trln? Would you heard about ten times greater market and that it start getting the same problems.
Markets now are interested not in inflation level, but in the trajectory of tightening the Fed's monetary policy. Just a week ago, market expectations regarding the rate after the Fed meeting on November 2 were in the following proportion: 25% chances for 3.75% (an increase of 0.5 percentage points from the current rate) and 75% chances for 4% (an increase of 0.75%).
Now expectations shifted sharply to the rate of 4% with a probability of 99% and a 1% increase to 4.25%. More fierce expectations regarding the Fed meeting on December 14. Now the rate of 4.5% has a probability of 37% and 4.75% - 62%. Just within a week, the probability of a rate of 4.75% has shifted from 7% to 62%!
In the dollar zone, rates around 5% is an absolutely crazy stuff! As a result, bonds collapsed.
Few months ago we've mentioned that US Treasury market liquidity is melting. New US Treasury issues just can't find the buyers, except, maybe, official dealers. Now this problem has official confirmation. Liquidity evaporates quickly. The volatility is off the scale. Once unthinkable, even the demand for government debt auctions is becoming a problem. Conditions are so worrisome that Treasury Secretary Janet Yellen took the unusual step on Wednesday of expressing concern about a potential trade disruption, saying after a speech in Washington that her ministry was "concerned about the loss of adequate liquidity" in the $23.7 trillion U.S. market. government securities. Make no mistake, if the Treasury bond market stops, the global economy and financial system will have much more serious problems than increased inflation.
The U.S. Treasury Department is asking primary dealers of U.S. Treasuries whether the government should buy back some of its bonds to improve liquidity in the $24 trillion market. Liquidity in the world's largest bond market has deteriorated this year partly because of rising volatility as the Federal Reserve rapidly raises interest rates to bring down inflation.
Indeed, as we've said, it is big problems with demand. Former major foreign buyers, such as China, Middle East countries, Russia and some others have become a net sellers due political confrontation, while EU, Japan, UK just have no free cash flows to invest in US bonds because of record high trade and current account deficits. The only resource that Fed has is inner one, but where to get enough funds to support 24 Trln market? Only interest payment for 31 Trln national debt stands for ~ 0.6 Trln. While the budget deficit is at record high of $1.14 Trln:
At the moment, there are no special buyers in US bonds. Everyone is staying away from this market now - from Japanese pension funds and insurers (Japan is the largest whale in US bonds) to foreign governments and US commercial banks. Demand in bonds has fallen sharply as the Fed reduces the balance sheet (QT) The US bond market has demonstrated a record-breaking decline in the history of the year, the volatility in the market has also increased to record values:
But this is not all yet. Fed Reserve just can't keep QT pace and can't sell off 8.9 Trln balance sheet, just because it earned less on its assets than it has paid for them. Fed reports loss on its operations this year within a decade. It seems that QT might be over before 2023 starts. The Federal Reserve is posting its first operating loss in years as interest rates soar and demand for US bonds craters. Fed data show the central bank reporting earnings remittances due to the US Treasury of negative $2.9 billion as of Oct. 5.
“The Fed's interest expense — the interest it pays banks and RRP counterparties — increases with each rate hike,” says Joseph Wang, a former trader on the central bank’s open markets desk and the founder of the Fed Guy blog. “The 75 basis point September rate hike pushed the Fed into an operating loss. With expectations for a ‘higher for longer’ Fed, the operating loss is likely to significantly increase in the coming months.”
Now by the way, exactly the period of banks earnings reports and majority of them are primary US Treasury dealers. Whether banks have ability to help US Treasury to support liquidity. And, in general, what doesn it mean to "provide liquidity"? It means that commercial banks have to buy government bonds with real negative interest rates, increasing their loss after adjustment to inflation. Once you have bought the bond - you immediately start paying for it. Meantime, recent US banks reports are not very good:
Morgan Stanley profit misses estimate as deals drought extends
Wells Fargo profit falls on sales scandal costs, higher reserves
JPMorgan profit beats estimates on gains from higher interest rates
Citigroup beats profit estimates as rate hikes bolster lending business
JPMorgan, Citigroup say higher capital requirements may hurt lending
Loss provisions gradually are rising, additionally, profit margin on long-term products becomes tighter as banks have to keep low rates on long-term loans while to fund them with higher current rate. JPMorgan Chase & Co Chief Executive Officer Jamie Dimon on Thursday warned that persistent and elevated inflation could spur interest rates to rise higher than 4.5%, as he cautioned about the possibility of a looming recession.
Meantime, winter will cost US households 28% more than a year ago, according to the US Department of Energy. Very bad data for the US stock market. Inflation in the US in winter may be very high, despite the tightening of the Fed rate. At the same time, core inflation will also be high, largely due to high rental prices. It seems that the world economy is in a "perfect storm" situation.
In General bond market by far already shows 4th worst ever performance:
Conclusion:
It seems guys, that crisis processes are accelerating and is ready to get out of control. All major central banks meet the same problems either to spin up inflation or to crush the domestic bond market. UK is a most bright example, Japan should follow next, while Fed is showing the same problems but they look smooth as they have more or less but significant reserve to drive it by far. EU market meets the same problems very soon. They could be even stronger due to more complex political and economical structure of the union.
Things that we see in the news are just the top of the iceberg. Problems probably are much greater but they stand in secret and turns public when it becomes impossible to hide them any more. Now we do not see any reasons to change our long-term targets on EUR (0.9) and GBP (0.95). For EUR perspectives might be even worse due to political situation. We will explain it in our Gold market report tomorrow.
Any bounce on EUR, GBP or any other currencies seem to be temporal. Fed is aimed on inflation fighting, at least in near term, which should keep strong pressure on all existed rivals. Until elections on 8th of November, Fed could let markets to show rallies, mostly as by product of stock market support. Democrats need to make the image of prosperity and improvements. So they could support stocks for few weeks, to calm down people a bit. At least historically, stock market always rises at the eve of election day. Once elections passed, everything should back to its own. So, do not be deceived with this trap.