Mounting Global Financial Instability, The UK Pension Industry Bailout; Entrenching Forces of Inflation

 Mounting Global Financial Instability, The UK Pension Industry Bailout; Entrenching Forces of Inflation 

 

The speed of the plunging currencies of China, Japan, and Europe (or the surging USD) makes the world vulnerable to a sudden stop and subsequently, a crisis. 

 

That was from this author last week.  

 

Are the following recent events the proverbial writing on the wall? (bold added) 

 

Euronews/Reuters, September 21: LONDON -The Bank of England stepped into Britain’s bond market to stem a market rout, pledging to buy around 65 billion pounds ($69 billion) of long-dated gilts after the new government’s tax cut plans triggered the biggest sell-off in decades. Citing potential risks to the stability of the financial system, the BoE also delayed on Wednesday the start of a programme to sell down its 838 billion pounds ($891 billion) of government bond holdings, which had been due to begin next week. “Were dysfunction in this market to continue or worsen, there would be a material risk to UK financial stability,” the BoE said. “This would lead to an unwarranted tightening of financing conditions and a reduction of the flow of credit to the real economy.” 

 

Financial Times, September 29: A pension meltdown forced the Bank of England to intervene in gilt markets on Wednesday. Executives told the Financial Times that markets barely dodged a Lehman-Brothers-like collapse – but this time with your mum’s pension at the centre of the drama. Problems with “pension plumbing” are what caused the mess. The culprit is said to be a popular pension strategy called liability-driven investing, or LDI. Leverage is a key element of many LDI strategies, and are basically a way pension funds can look like they’re an annuity without making the full capital commitment of becoming one.  

As one would note, the developing market tumult starts with malinvestments funded by extensive leveraging, which are all products of the zero-bound rate or "easy money" regime and financial engineering. 

 

In the ten years through 2020, reports have indicated the UK pension industry's liabilities through their exposure to Liability Driven Investing (LDI) hedging strategies have tripled to £1.5 trillion ($1.7TN)!   

  

The industry's massive exposure to fixed income, derivatives, repos, and other forms of securitizations through leveraging made them increasingly fragile to extreme market volatility.  Thus, the sharp drop in bond prices and the sterling forced the industry to face a chain of collateral and margin calls, compelling the frantic and intense liquidations to raise cash! 

  

And with liquidity rapidly drying up, the Bank of England (BoE) attempted to stanch the bleeding with an incredible policy U-turn from the initial plan of Quantitative Tightening (reducing balance sheet) to Quantitative Easing (expansion again)!  Or, to infuse liquidity, it will buy instead of selling bonds.  

But there is no free lunch. 

 

Such subsidies have sent the UK's credit default swaps (CDS) to pandemic highs! 

 

And instead of pruning its assets, the BoE's balance sheet will rise further or remain at ALL-Time highs. 

 

And as liquidity in the treasury markets has been swiftly depleting, not only in the UK but in other major European sovereigns, including the US, sooner or later, these nations may also mimic the BoE. 

 

For the same reasons, South Korean authorities have floated to the public its intent to buy bonds. 

 

Xinhua, September 28: South Korea's finance ministry and the central bank said Wednesday that they will buy back government bonds later this week to tackle soaring bond yields. Senior officials from the Ministry of Economy and Finance, the Bank of Korea (BOK) and financial regulators had a meeting to deal with the recent volatility surge in the financial market. The finance ministry decided to buy back 2 trillion won (1.4 billion U.S. dollars) worth of government bonds on Friday, while the BOK will purchase Treasury bonds worth 3 trillion won (2.1 billion dollars) from the market Thursday. (bold added) 

 

So while many central banks may still be hiking, the unfolding events may prompt them to reconsider their present actions.  

 

They may slow or stop rate hikes altogether while reopening the tap of asset purchases for liquidity injections. 

 

Global financial markets have responded violently to the slight trimming of central bank assets of the Fed, ECB and BoJ, indicating the embedded fragility. 

 

And the more chaotic the events, the greater the likelihood that central banks may elect towards a 'pivot.' 

Yet, the other options authorities are likely to impose are a chain of interventions and eventual controls: currency or FX, capital, price and wage, trade, border/mobility, and even people. 

 

Let us cite some recent instances. 

 

The Bank of Japan (BoJ) reportedly exhausted some USD 19.6 billion in September to intervene in the currency market to support its currency, the yen. 

 

In support of the USD-Hong Kong peg, the Bangkok Post and SCMP reported a few days ago that the Hong Kong Monetary Authority intervened "in the market 32 times this year, buying a total of HK$215.035 billion and selling US$27.39 billion amid persistent capital outflows. Its current intervention has surpassed in size measures taken to support the weak Hong Kong dollar during the last interest-rate rise cycle when it bought HKcopy03.48 billion in 2018 and HK$22.13 billion in 2019." 

 

Taiwanese officials initially floated the idea of FX and a ban on short sales. Later, they denied this. 

 

Interventions to prop up domestic currencies have led to substantial declines in the US Treasury holdings of global central banks. 

 

Finally, as the energy crunch sweeps into Europe, member states have already embarked on bailing out consumers and producers. 

 

Yahoo/Bloomberg, September 21: Germany and the UK announced energy bailouts to avoid an economic collapse and take the sting out of soaring prices, with European governments spending 500 billion euros ($496 billion) by one estimate to help consumers and businesses…The bailouts announced in Berlin and London coincide with fresh estimates from the Bruegel think-tank that the total spend by European nations on easing the energy crisis for households and businesses is nearing 500 billion euros. The European Union’s 27 member states have so far earmarked 314 billion, not including other major spending like nationalization plans, it said 

 

Winter is coming, and we can only guess that the bailouts will intensify. 

 

So how will European authorities finance this, given the current climate? 

 

For these reasons, "inflation" would only become structurally embedded as the path-dependent stance of policymakers remains in favor of inflating the system. 

 

And yet one of the immediate backlashes from these bailouts is the developing fissure among member states of the Eurozone. 

 

But even if central banks "pivot," such conditions are unlikely to fuel the return of TINA. 

 

There is much to deal with, but we can't cover them at once. 

Quote of the Day: 666; Chart of the Day: British Hoard Cash!

666: BoE & RBA easing this week…global central banks have now cut rates 666 times since Lehman; extreme monetary policy more positive for bonds ($1.0tn inflows since LEH) than stocks ($375bn inflows).

From Team BoFAML led by Michael Harnett (courtesy of FT Alphaville) 

Lucky number or jinx?

Chart of the Day... 

From Zero Hedge: 

As Sky News reports, in the weeks following the EU referendum, the rate at which households and businesses built up holdings of UK banknotes and coins rose above 8% a year for the first time since 2009, according to a Sky News analysis of Bank of England statistics.

The growth rate of cash in circulation has more than doubled since January, when it was running at 4% a year, with a sudden acceleration in the weeks following the EU poll.

In cash terms, the amount of notes and coins outside the banking system rose by £1.2bn since the end of May, and by £5.9bn in the past year - the biggest annual rise on record.

Sky News has also found that the proportion of UK banknotes circulating outside the banking system - in people's pockets, stored at home and outside the country - has now hit the highest level since 1979, as a percentage of GDP.

Reason? Back to Zero Hedge (bold mine)

Simon Ward, economist at Henderson Global Investors, said:

"People may be hoarding notes not for safety reasons but because the Bank of England is expected to cut interest rates significantly, possibly even imposing a negative rate on bank reserves, forcing banks to start charging for operating current accounts."

"Hoarding may also reflect increased demand for £50 notes due to uncertainty about their future supply,"

"(BOE) Governor Carney confirmed in June that there are no plans to introduce a plastic version of the £50 note, fuelling fears raised by Mr (BOE chief economist) Haldane's earlier speech that the Bank intends to restrict the future supply of cash in order to create scope for interest rates to fall further below zero."

Bank of England Panics: Cut Rates, Adds QE, Will Buy Corporate Debt and Launched Term Funding Scheme

Well part of the BOE's present announcement has already been telegraphed in response to Brexit. 

But the unveiling of the other segments of the BOE Governor Mark Carney's bazooka signifies a manifestation of desperation. 

Chart from Bloomberg

From the Telegraph.co.uk

Bank of England cuts interest rates for first time since 2009

Bank of England slashes UK growth forecasts

Pound slides as Bank of England cuts interest rates

FTSE 100 jumps 1pc on Bank of England action

UK 10-year government bond yield falls to new record low

China stocks roughly flat as policy dilemmas cause uncertainty

The Bank of England has cut interest rates for the first time in more than seven years as it unveiled a package of measures designed to prevent a recession following the Brexit vote.

Policymakers voted unanimously to cut rates to 0.25pc on Thursday, from a previous record low of 0.5pc.

Bank Rate had previously been held at 0.5pc since March 2009, and officials signalled that a "markedly" weaker growth outlook meant a further cuts towards zero were likely in the coming months.

In a 170bn package of additional measures designed to stimulate the economy, the Bank announced it would also.......... Expand its quantitative easing programme by 60bn over six months, taking its stockpile of asset purchases up to 435bn over the coming six months, from 375bn today.

Buy up to 10bn of high quality corporate debt starting in September in a bid to drive down corporate funding costs. Policymakers said buying these bonds "could provide more stimulus than the same amount of gilt purchases". The Bank said the size of the pool of eligible bonds was likely to be around 150bn.

Launch a "Term Funding Scheme" designed to offset the impact of cutting interest rates on bank profits. This will allow commercial banks to borrow a proportion of their outstanding lending to UK businesses and households for four years at rates close to 0.25pc. The scheme will be funded by new money created by the Bank, with usage estimated to be up to 100bn.

Staff slashed their year-ahead UK growth forecasts on Thursday by the biggest margin since it started publishing quarterly economic forecasts in 1993, but stopped short of forecasting a Brexit-induced recession.

Growth in 2017 is now forecast at 0.8pc, down from a previous forecast of 2.3pc in May.

However, it expects expects the economy to grow by 0.1pc in the third quarter, and to expand slightly in the final three months of the year, even though it said the UK was likely to see "little growth in GDP in the second half of this year".

This would see the UK avoid a technical recession, defined as two consecutive quarters of economic decline.

Like almost every central bank, the BOE's addiction to monetary means to solve real economic problems extrapolates to an act of desperation. Instead of alleviating the present predicament, such drastic measures will only exacerbate on the extant malinvestments, compound on price-economy distortions and deepen uncertainties that will lead UK to a recession. 

Said differently, it will not be Brexit that will serve as the main cause of a recession but the BoE's previous boom bust policies which will exacerbated by the supplemental ones added today.

Property prices have already been in a slump even before Brexit. From Bloomberg (August 3): Home prices in London’s Knightsbridge district dropped 7.3 percent in the 12 months through July, the biggest annual decline in almost seven years, as Britain’s vote to leave the European Union accelerated price drops caused by rising taxes. Values fell 1.5 percent across central London’s best districts, with prices in Chelsea down 7.2 percent, broker Knight Frank said in a Wednesday report. Rents in the area known as prime central London fell 3.6 percent in the period and the number of new properties offered for lease rose 49 percent in the second quarter, according to data compiled by the broker. 

Brexit only served as an aggravating circumstance to what has been an economy dependent on bubbles.

In the current oxymoronic milieu, while central banks and governments panic on their respective economies to resort to desperate measures, stock market participants indulge in panic buying!