Sive Morten
Special Consultant to the FPA
- Messages
- 18,648
Fundamentals
This week we have seen the epic event, guys, and I'm speaking not about North streams blast. Situation in UK and BoE decision to restart QE that is what really matters. This even has few levels of importance. Of course we explain you everything below, what has happened, why and what consequences might happen. It is not correct to suggest that this is just inner UK problems. Absolutely not. This is an early example what could happen soon in other countries - EU, Japan. So, from the structural crisis point of view this situation is exceptional.
We've dedicated a lot of time to explanation the background of structural crisis, why it calls structural and why it can't be defeated by just changing of the interest rate. Also we explained how particular it impacts on different spheres - employment, interest rates, real estate market, public wealth etc. on example of the US statistics. Now you could see absolutely the same effect across the board in many other countries.
For a long term we talked about negative US interest rates, but the same thing we have in Germany, where real yields are negative for 77 months in a row with "-7.89%" current level. In general global bonds performance confirms that this is the global structural crisis - market has lost $12 Trln from ATH, shares of developer HELMA Eigenbau collapsed by almost 25%, suggesting housing boom is over in Germany, EU corporate default spreads stand near maximum levels - etc, etc.
We could keep this sequence of facts but you probably know that as well as me. The US market alone has lost $50+ Trln. of capitalization in recent few months:
According to big banks analysis, say, Morgan Stanley - the process is far from to be over, according to long-term correlation to Fed interest rates. Chances on recession now stand around 98%.
These few statistics examples just show that crisis if marching over the planet, and all things that we've discussed previously is gradually becoming the reality. And we're not even on a half way yet. The global financial system, based on the US Dollar is falling apart. We have returned to the situation at the beginning of the month, a typical picture of a structural crisis, when every month in certain countries records are set for falling sales, rising prices or declining production. As it usually happens, a sharp deterioration in some countries is followed by a small rollback, which official commentators then pay attention to, but we look at the systemic picture and it turns out to be quite typical.
As well as in the US where we've said that the CPI has to converge to PPI but not vice versa, as production is primary compares to consumption, the same thing we see now in Germany. It hits CPI numbers above 10%. It is already double-digit and it is possible that the reality is higher than official figures. In any case, the gap with 45% industrial inflation is too high. Thus, consumer inflation would begin to catch up to industrial 45% inflation in Germany as well. That is, the growth of consumer inflation will continue. Regardless of the campaigns of the leadership of the European Central Bank. However, England has already pointed the way, and the euro is quite actively falling against the US dollar.
So, here is not too many things to comment, concerning the progress of the crisis - it goes precisely as we've discussed, with expected fruits. And should bring more, much more in nearest future. Next victim should become the job market - employment is stagnating while the part of part-time workers is fastly growing.
But now we would like to share with you our thoughts on UK situation. The importance of these events is difficult to overvalue.
UK situation and recent BoE reaction
From one point of view, in recent BoE decision to re-start QE we see nothing new. The same "capitulation" happened in July, when ECB has announced TPI, calling the same QE with new word. But by fact the core is the same - denying tightening policy and returning to the money printing. ECB balance has increased last week for 20 Bln by the way...
There was a panic and absolute hell in the UK debt market this week. In just seven trading sessions, the yield of UK government bonds fell by more than 160 bps (1.6 pp) from 3.05% to 4.68% on 3-year bonds, where the main blow fell.
For the modern architecture of the UK financial system, such a shock is nonsense.
Many media outlets have written about a record tax cut in 50 years, but that's not the reason. This is just a surface background, the real reason is deep and stands in strong mismatch of money and debt markets from inflation, which generates record negative real rates, draining demand for debt instruments, preventing the financing of holes in the budget of the state and corporations. Such capitulation in the debt market is a consequence of the gap of inadequate policy of the Bank of England and record inflation in the UK for 40-45 years.
Concerning taxes. The package of subsidies and tax cuts will cost at least 150 billion pounds, which is equivalent to 17% of budget revenues, leading to an inevitable deficit that will be financed by borrowing at least 73 billion pounds.
Thus It turns that the Bank of England, tightens the policy while the Ministry of Finance, on the contrary, conducts a sharply stimulating policy. Such disorganized performance of two major financial institutes acted as an indirect trigger for disorientation of debt market participants.
The energy subsidy will amount to 60 billion pounds in the next 6 months. All this can create a record budget deficit and increase inflationary pressure to pour money back in!
Once panic has started it has hit the most bond - exposed financial institutes - pension funds. Pension funds use Gilts bonds as a collateral to get liquidity for investing and return enhancing and have to holds the margin. When Gilts start falling pension funds have to increase margin to compensate drawdown that they were unable to fulfill. As a result BoE had to urgently step in and start buying bonds to stabilize yields:
Pension fund panic led to Bank of England’s emergency intervention
Long-dated bonds represent around two-thirds of Britain’s roughly £1.5 trillion ($1.6 trillion) in so-called liability driven investment funds, which are largely leveraged and often use gilts as collateral to raise cash.
These LDIs are owned by final salary pension plans, which risked falling into insolvency as the LDIs were forced to sell more gilts, in turn driving down prices and sending the value of their assets below that of their liabilities. Final salary, or defined benefit, pension plans are workplace pensions popular in the U.K. that provide a guaranteed annual income for life upon retirement based on the worker’s final or average salary.
In its emergency purchase of long-dated gilts, the Bank of England is setting out to support gilt prices and allow LDIs to manage the sale of these assets and the repricing of gilts in a more orderly fashion, so as to avoid a market capitulation.
Echo of this turmoil hits many spheres, especially mortgages. The country's largest mortgage lender Halifax said it was withdrawing its fee-paying mortgage products - where borrowers could pay an arrangement fee in exchange for a lower interest rate - and moving to a full fee-free range. While British pension funds with big losses in gilt market derivatives have sought emergency funds from the companies they manage money for as they race to dump assets to raise cash, industry sources said on Friday.
The BlackRock, the major player on LDI market threatened to halt trading at height of UK market tumult. BlackRock has been accused of failing to protect pension fund clients by threatening to halt trading in certain funds at the height of this week’s UK bond market tumult. In a memo sent on Wednesday morning, BlackRock told clients using its liability-driven investing strategies that it would freeze “funds more at risk of assets being exhausted” and move the assets to cash. One professional trustee said the actions left pension schemes potentially unable to take steps to protect their members.
So, as a result BoE has announced the QE, suggesting daily buyback actions starting Sep. 28 until October 14 with the starting amount of 5 Bln pounds with very wide, almost unlimited potential.
It should be noted here that the capitulation of the Bank of England happens right in the beginning of the policy tightening. The key rate of the Bank of England is 2.25% with inflation at 10%. Now plans to reduce the balance sheet have been postponed, QE has been resumed on a potentially unlimited scale until the situation in the debt markets stabilizes.
The nuance is that the faster the Bank of England "stabilizes the situation" and the more money they print & pump, the stronger the inflationary pressure and lower the markets confidence, which in turn further increases the pressure on the debt markets, provoking the next waves of QE.
Once we already talked about it. With the first bell of collapse everything will be reversed back. As the system breakdown happened, all plans were canceled, returned to the previous course. Do not expect a different policy from the ECB and the Fed.
But now, guys, we're coming to the most interesting thing. Obviously we start talking about this situation not because we're so interested with UK economy performance, but because it relates to global crisis and clarifies few issues. It means not less but crushing of the Bretton-Woods system. If somebody tells me few years ago that the US lets collapse all world currencies, including pound sterling, I would suggest that this person is nuts. But the major question is why this is happening?
And answer is simple - the US has no resources any more to support the stability globally. All their efforts are aimed now only on the stability of the US economy and they do not care about others. Available funds are melting and not enough for all parts of the system:
And the events in England show that the United States has no more resources to maintain the stability of the global monetary system. It should be noted that another confirmation of this was the elections in Italy. The right-wing coalition that won the elections said quite harshly that it would protect the standard of living of the population. It is economically impossible to do this within the euro zone, which means that Italy will leave the euro zone and revive the national currency, which can be issued and support the social part of the budget. Right forces in EU get more popularity in many countries, trying to put interests of own people on the first place, return its sovereignity, control over currency, cashflows. Now all these stuff is under Brussels control. V. Orban is very bright example, now it is Italy case, but this trend is becoming more and more popular in other countries.
Meantime numerous statements of the Fed's leaders, which were made this week, showed that they are only interested with the situation in the United States, and particular the decline in inflation. The stability of the global financial system is clearly not in the interests of the American regulator today, or is a deeply secondary task. And those countries that most of all involved in this system will carry the most hurt from the Fed policy. The crushing of the system perfectly indicated by the performance of the global currencies. Just tell me when emerging currencies were showing best performance? But now they do. The least integrated in so-called "Global western economy" feels no big pain, although no doubts have problems. Obviously, such a performance of closest to US Dollar allies as EUR, GBP, JPY are not in favor of system stability. And the fact that the US do nothing to fix it gives only the one conclusion - they can't do it.
Finally, just few minutes ago the breaking news comes - Fed intends to make urgent meeting on Monday, October 3rd 2022. It seems that something has broken - be prepared for bumpy ride, guys. Everytime when Dollar index hits the new lows, something bad comes.
If we see such a process in the UK that in fact the flesh and blood with the US, what we should expect to see in EU? With the big disbalances, rising political tensions inside the EU, loosing of heavy industry and falling population wealth - situation just can't be better. BoE is a first bell, ECB will be second, but the crush will be heavier. Now I'm getting doubts on 0.9 target, with more and more gut filling that EUR crush could not stop there. And only some extraordinary events in the US could prevent it. I don't know, maybe the results of November elections or something else. Now I would say that EUR should drop at least to 0.9...
P.S.
Concerning North Stream... There are two major indirect indicators about who has done it. I'm speaking neither about J. Biden promise to blast it nor about Sikorsky tweet, nor common sense. The first indicator is 90+% of Germans think that it is the US/UK deal, which is a bit unexpected, to say the least. (just read their comments and publics) . Second - all western media keeps silence on this incident. We know to whom western media belongs to, and it means that they have got an instructions to avoid this topic. Why? This is rhetoric question. This precedent could get a lot of political, economical and event military consequences but this topic beyond the scope of FX report.
This week we have seen the epic event, guys, and I'm speaking not about North streams blast. Situation in UK and BoE decision to restart QE that is what really matters. This even has few levels of importance. Of course we explain you everything below, what has happened, why and what consequences might happen. It is not correct to suggest that this is just inner UK problems. Absolutely not. This is an early example what could happen soon in other countries - EU, Japan. So, from the structural crisis point of view this situation is exceptional.
We've dedicated a lot of time to explanation the background of structural crisis, why it calls structural and why it can't be defeated by just changing of the interest rate. Also we explained how particular it impacts on different spheres - employment, interest rates, real estate market, public wealth etc. on example of the US statistics. Now you could see absolutely the same effect across the board in many other countries.
For a long term we talked about negative US interest rates, but the same thing we have in Germany, where real yields are negative for 77 months in a row with "-7.89%" current level. In general global bonds performance confirms that this is the global structural crisis - market has lost $12 Trln from ATH, shares of developer HELMA Eigenbau collapsed by almost 25%, suggesting housing boom is over in Germany, EU corporate default spreads stand near maximum levels - etc, etc.
We could keep this sequence of facts but you probably know that as well as me. The US market alone has lost $50+ Trln. of capitalization in recent few months:
According to big banks analysis, say, Morgan Stanley - the process is far from to be over, according to long-term correlation to Fed interest rates. Chances on recession now stand around 98%.
These few statistics examples just show that crisis if marching over the planet, and all things that we've discussed previously is gradually becoming the reality. And we're not even on a half way yet. The global financial system, based on the US Dollar is falling apart. We have returned to the situation at the beginning of the month, a typical picture of a structural crisis, when every month in certain countries records are set for falling sales, rising prices or declining production. As it usually happens, a sharp deterioration in some countries is followed by a small rollback, which official commentators then pay attention to, but we look at the systemic picture and it turns out to be quite typical.
As well as in the US where we've said that the CPI has to converge to PPI but not vice versa, as production is primary compares to consumption, the same thing we see now in Germany. It hits CPI numbers above 10%. It is already double-digit and it is possible that the reality is higher than official figures. In any case, the gap with 45% industrial inflation is too high. Thus, consumer inflation would begin to catch up to industrial 45% inflation in Germany as well. That is, the growth of consumer inflation will continue. Regardless of the campaigns of the leadership of the European Central Bank. However, England has already pointed the way, and the euro is quite actively falling against the US dollar.
So, here is not too many things to comment, concerning the progress of the crisis - it goes precisely as we've discussed, with expected fruits. And should bring more, much more in nearest future. Next victim should become the job market - employment is stagnating while the part of part-time workers is fastly growing.
But now we would like to share with you our thoughts on UK situation. The importance of these events is difficult to overvalue.
UK situation and recent BoE reaction
From one point of view, in recent BoE decision to re-start QE we see nothing new. The same "capitulation" happened in July, when ECB has announced TPI, calling the same QE with new word. But by fact the core is the same - denying tightening policy and returning to the money printing. ECB balance has increased last week for 20 Bln by the way...
There was a panic and absolute hell in the UK debt market this week. In just seven trading sessions, the yield of UK government bonds fell by more than 160 bps (1.6 pp) from 3.05% to 4.68% on 3-year bonds, where the main blow fell.
For the modern architecture of the UK financial system, such a shock is nonsense.
Many media outlets have written about a record tax cut in 50 years, but that's not the reason. This is just a surface background, the real reason is deep and stands in strong mismatch of money and debt markets from inflation, which generates record negative real rates, draining demand for debt instruments, preventing the financing of holes in the budget of the state and corporations. Such capitulation in the debt market is a consequence of the gap of inadequate policy of the Bank of England and record inflation in the UK for 40-45 years.
Concerning taxes. The package of subsidies and tax cuts will cost at least 150 billion pounds, which is equivalent to 17% of budget revenues, leading to an inevitable deficit that will be financed by borrowing at least 73 billion pounds.
Thus It turns that the Bank of England, tightens the policy while the Ministry of Finance, on the contrary, conducts a sharply stimulating policy. Such disorganized performance of two major financial institutes acted as an indirect trigger for disorientation of debt market participants.
The energy subsidy will amount to 60 billion pounds in the next 6 months. All this can create a record budget deficit and increase inflationary pressure to pour money back in!
Once panic has started it has hit the most bond - exposed financial institutes - pension funds. Pension funds use Gilts bonds as a collateral to get liquidity for investing and return enhancing and have to holds the margin. When Gilts start falling pension funds have to increase margin to compensate drawdown that they were unable to fulfill. As a result BoE had to urgently step in and start buying bonds to stabilize yields:
Pension fund panic led to Bank of England’s emergency intervention
- To prevent an “unwarranted tightening of financing conditions and a reduction of the flow of credit to the real economy,” the FPC said it would buy gilts on “whatever scale is necessary” for a limited time.
- Central to the bank’s extraordinary announcement was panic among pension funds, with some of the bonds held within them losing around half their value in a matter of days.
- Analysts are hoping that a further intervention from either Westminster or the City will help assuage the market’s concerns, but until then, choppy waters are expected to persist.
Long-dated bonds represent around two-thirds of Britain’s roughly £1.5 trillion ($1.6 trillion) in so-called liability driven investment funds, which are largely leveraged and often use gilts as collateral to raise cash.
These LDIs are owned by final salary pension plans, which risked falling into insolvency as the LDIs were forced to sell more gilts, in turn driving down prices and sending the value of their assets below that of their liabilities. Final salary, or defined benefit, pension plans are workplace pensions popular in the U.K. that provide a guaranteed annual income for life upon retirement based on the worker’s final or average salary.
In its emergency purchase of long-dated gilts, the Bank of England is setting out to support gilt prices and allow LDIs to manage the sale of these assets and the repricing of gilts in a more orderly fashion, so as to avoid a market capitulation.
Echo of this turmoil hits many spheres, especially mortgages. The country's largest mortgage lender Halifax said it was withdrawing its fee-paying mortgage products - where borrowers could pay an arrangement fee in exchange for a lower interest rate - and moving to a full fee-free range. While British pension funds with big losses in gilt market derivatives have sought emergency funds from the companies they manage money for as they race to dump assets to raise cash, industry sources said on Friday.
The BlackRock, the major player on LDI market threatened to halt trading at height of UK market tumult. BlackRock has been accused of failing to protect pension fund clients by threatening to halt trading in certain funds at the height of this week’s UK bond market tumult. In a memo sent on Wednesday morning, BlackRock told clients using its liability-driven investing strategies that it would freeze “funds more at risk of assets being exhausted” and move the assets to cash. One professional trustee said the actions left pension schemes potentially unable to take steps to protect their members.
So, as a result BoE has announced the QE, suggesting daily buyback actions starting Sep. 28 until October 14 with the starting amount of 5 Bln pounds with very wide, almost unlimited potential.
It should be noted here that the capitulation of the Bank of England happens right in the beginning of the policy tightening. The key rate of the Bank of England is 2.25% with inflation at 10%. Now plans to reduce the balance sheet have been postponed, QE has been resumed on a potentially unlimited scale until the situation in the debt markets stabilizes.
The nuance is that the faster the Bank of England "stabilizes the situation" and the more money they print & pump, the stronger the inflationary pressure and lower the markets confidence, which in turn further increases the pressure on the debt markets, provoking the next waves of QE.
Once we already talked about it. With the first bell of collapse everything will be reversed back. As the system breakdown happened, all plans were canceled, returned to the previous course. Do not expect a different policy from the ECB and the Fed.
But now, guys, we're coming to the most interesting thing. Obviously we start talking about this situation not because we're so interested with UK economy performance, but because it relates to global crisis and clarifies few issues. It means not less but crushing of the Bretton-Woods system. If somebody tells me few years ago that the US lets collapse all world currencies, including pound sterling, I would suggest that this person is nuts. But the major question is why this is happening?
And answer is simple - the US has no resources any more to support the stability globally. All their efforts are aimed now only on the stability of the US economy and they do not care about others. Available funds are melting and not enough for all parts of the system:
And the events in England show that the United States has no more resources to maintain the stability of the global monetary system. It should be noted that another confirmation of this was the elections in Italy. The right-wing coalition that won the elections said quite harshly that it would protect the standard of living of the population. It is economically impossible to do this within the euro zone, which means that Italy will leave the euro zone and revive the national currency, which can be issued and support the social part of the budget. Right forces in EU get more popularity in many countries, trying to put interests of own people on the first place, return its sovereignity, control over currency, cashflows. Now all these stuff is under Brussels control. V. Orban is very bright example, now it is Italy case, but this trend is becoming more and more popular in other countries.
Meantime numerous statements of the Fed's leaders, which were made this week, showed that they are only interested with the situation in the United States, and particular the decline in inflation. The stability of the global financial system is clearly not in the interests of the American regulator today, or is a deeply secondary task. And those countries that most of all involved in this system will carry the most hurt from the Fed policy. The crushing of the system perfectly indicated by the performance of the global currencies. Just tell me when emerging currencies were showing best performance? But now they do. The least integrated in so-called "Global western economy" feels no big pain, although no doubts have problems. Obviously, such a performance of closest to US Dollar allies as EUR, GBP, JPY are not in favor of system stability. And the fact that the US do nothing to fix it gives only the one conclusion - they can't do it.
Finally, just few minutes ago the breaking news comes - Fed intends to make urgent meeting on Monday, October 3rd 2022. It seems that something has broken - be prepared for bumpy ride, guys. Everytime when Dollar index hits the new lows, something bad comes.
If we see such a process in the UK that in fact the flesh and blood with the US, what we should expect to see in EU? With the big disbalances, rising political tensions inside the EU, loosing of heavy industry and falling population wealth - situation just can't be better. BoE is a first bell, ECB will be second, but the crush will be heavier. Now I'm getting doubts on 0.9 target, with more and more gut filling that EUR crush could not stop there. And only some extraordinary events in the US could prevent it. I don't know, maybe the results of November elections or something else. Now I would say that EUR should drop at least to 0.9...
P.S.
Concerning North Stream... There are two major indirect indicators about who has done it. I'm speaking neither about J. Biden promise to blast it nor about Sikorsky tweet, nor common sense. The first indicator is 90+% of Germans think that it is the US/UK deal, which is a bit unexpected, to say the least. (just read their comments and publics) . Second - all western media keeps silence on this incident. We know to whom western media belongs to, and it means that they have got an instructions to avoid this topic. Why? This is rhetoric question. This precedent could get a lot of political, economical and event military consequences but this topic beyond the scope of FX report.
