It would have been a nonevent; inconsequential. Confirming New Cycle Dynamics, the Truss government’s “mini budget” has unleashed absolute mayhem. Pension funds blowing up. Emergency central bank rescue operations. Global market instability. UK’s Treasury Secretary sacrificed after a mere 38 days, while an entire government hangs in the balance.
Friday evening Financial Times headlines: “Gilts in Fresh Slide as Investors Say Truss U-turn Did Not Go Far Enough.” “Can Liz Truss Survive as UK Prime Minister?”; “Austerity Beckons as Truss Seeks to Restore Britain’s Reputation with Investors.” And “UK Debacle Shows Central Bank ‘Tough Love’ is Here to Stay.”
The world has changed right before our eyes.
It has been one of my favored rhetorical questions for the past couple decades: Is “money” (monetary inflation) the solution or the problem? The answer is obvious – has been for some time, and I’ll assume central bankers have accepted the harsh reality.
Years of unprecedented monetary inflation created false realities. The perception of endless cheap (free) “money” distorted how our market, economic, financial, political and social systems function. The long-overdue adjustment period has commenced, and there’s every reason to expect it to be especially brutal. So quickly, so many things are different. There were this week more tremors and that nagging feeling the ground was about to give way.
I feel for Liz Truss. She could very well be the shortest-serving Prime Minister in UK history. Central bankers and bond markets have merrily accommodated many a crazy budget. Now they’re running scared, leaving stunned politicians to try to figure out what can work in today’s new reality.
In a microcosm of unfolding global phenomena, the UK faces dual fiscal and monetary policy crises of confidence. And to this point in the UK, uncompromising markets want nothing to do with additional fiscal spending and monetary stimulus.
October 12 – Reuters (Dhara Ranasinghe, Harry Robertson, Tommy Wilkes): “Bank of England Governor Andrew Bailey has been unequivocal: the central bank will end emergency support for bonds on Friday. Yet with markets showing few signs of stabilising, the BoE may have little choice but to come back with more. Britain’s government borrowing costs jumped again on Wednesday with 20- and 30-year bond yields hitting 20-year highs after Bailey told pension funds on Tuesday they had three days to fix liquidity problems before emergency BoE bond-buying ends. The central bank is caught between a rock and a hard place. On the one hand it is navigating what it has called a ‘material risk to financial stability’ with the gilt market rout exposing vulnerabilities in the pensions sector. But buying bonds doesn’t sit well with the BoE’s mandate to control surging inflation and BoE officials are anxious to avoid giving the impression that they are buying bonds to support the fiscal plans of the government.”
After a decade of becoming fully embedded in market perceptions, prices and structures, as well as within governmental planning and budgets, business strategies, economic structure and the like – how do central bankers these days signal that “whatever it takes” has run its course? Can it be done without unleashing instability virtually everywhere?
Prime Minister Truss and BOE Governor Bailey could commiserate over a cup of English breakfast tea. Truss is forced to placate the bond market, while trying to avoid the appearance of a wimpy pushover quickly caving on her government’s entire fiscal agenda. It’s messy U-turns and the short-timer look of indecision.
Bailey must prevent bond market and pension system breakdowns, while not completely opening the monetary floodgates with inflation raging and the pound fragile. The BOE’s emergency bond support was to expire Friday, though few believe that’s doable. Most remain convinced that central banks are forever subjugated to “whatever it takes” market crash protection. For the BOE, it’s messy U-turns and the unsettling look of indecision. Credibility hanging in the – it’s dangling.
UK gilt yields traded as high as 4.63% in Wednesday trading, dropping to a low of 3.89% early Friday, before ending the week up 10 bps to 4.34%. Two-year UK yields traded at a 4.40% high intraday Monday, with a Friday low of 3.46% (closed the week down 25bps to 3.87%). The pound traded at a low of 1.092 Wednesday and a high of 1.138 on Thursday, before ending the week up 0.8% to 1.118.
It was an ominous week for global bank CDS.
UK’s Barclays Bank CDS jumped 11 to 147 bps, the high back to July 2013 (“taper tantrum”). Barclays CDS traded at 105 bps on September 15th. NatWest CDS increased four to 131 bps, and Lloyds rose seven to 97 bps (trading this week to the high since 2016).
Curiously, US banks were again up near the top of this week’s CDS leaderboard, with the majors all seeing CDS Friday closes at highs since March 2020. JPMorgan CDS rose eight to 112 bps, with Bank of America up nine to 121 bps. Citigroup CDS rose seven to 139 bps, Goldman 11 to 142 bps, and Morgan Stanley nine to 140 bps. Elsewhere, Deutsche Bank CDS increased four to 173 bps (trading intraday Wednesday to 189 bps); Societe Generale 13 to 110 bps (intraday Thursday to 120 bps); and troubled Credit Suisse 12 to 318 bps (intraday Thursday to 341 bps).
Thursday’s stock market volatility was noteworthy. The S&P500 traded down to 3,492 following worse-than-expected CPI data, only to post a stunning 5.5% intraday rally (closing the session up 2.6%). The S&P500 then traded up to 3,712 in early-Friday trading, before reversing 3.5% lower to end the week at 3,583 (down 1.6%).
U.S. investment-grade corporate spreads-to-Treasuries widened 11 bps this week to 1.63 percentage points, the widest level since May 2020. More support this week for the singular global Bubble thesis.
October 10 – Reuters (Davide Barbuscia): “Government bond prices around the world are moving in tandem, reducing investors’ ability to diversify their portfolios and raising concerns of being blindsided by market gyrations. Correlations between currency-adjusted returns on the government debt of countries such as the U.S., Japan, the U.K. and Germany are at their highest level in at least seven years, data from MSCI showed, as central banks around the world ramp up their fight against inflation.”
October 11 – Wall Street Journal (Matt Wirz and Caitlin Ostroff): “Fallout from the crisis in U.K. financial markets has hit a faraway corner of Wall Street: the trillion-dollar market for collateralized loan obligations. Once a niche product, CLOs are now widely held by investors around the world, including the British pensions, insurers and funds that got caught by the recent crash in U.K. currency and government-bond markets. Many of them sold CLO bonds to meet margin calls, sending prices of the securities tumbling well below their intrinsic value, analysts and fund managers said.”
Sometimes you just scratch your head…
October 10 – Bloomberg (Ott Ummelas and Niclas Rolander): “Former Federal Reserve Chair Ben S. Bernanke and two US-based colleagues won the 2022 Nobel Prize in Economics for their research into banking and financial crises. Douglas Diamond, Philip Dybvig and the one-time central banker will share the 10-million-kronor ($885,000) award, the Royal Swedish Academy of Sciences announced… ‘The laureates have provided a foundation for our modern understanding of why banks are needed, why they are vulnerable and what to do about it,’ John Hassler, professor of Economics and member of the prize committee, told reporters… ‘In the laureates’ work, it is shown that deposit insurance is a way of short-circuiting the dynamics behind bank runs. With deposit insurance, there is no need to run to the bank.’”
On second thought… Few seem to appreciate the irony of Bernanke receiving the Nobel Prize in Economics just as central bank inflationist doctrine faces a monumental crisis of confidence. He won his Nobel Prize for his research on bank runs. No one has done more to ensure a run on global market instruments.
“The correct interpretation of the 1920s, then, is not the popular one – that the stock market got overvalued, crashed, and caused a Great Depression. The true story is that monetary policy tried overzealously to stop the rise in stock prices. But the main effect of the tight monetary policy, as Benjamin Strong had predicted, was to slow the economy – both domestically and, through the workings of the gold standard, abroad… This interpretation of the events of the late 1920s is shared by the most knowledgeable students of the period, including Keynes, Friedman and Schwartz, and other leading scholars of both the Depression era and today… monetary policy had already turned exceptionally tight by late 1927… A small compensation for the enormous tragedy of the Great Depression is that we learned some valuable lessons about central banking. It would be a shame if those lessons were to be forgotten.” Ben Bernanke, “On Milton Friedman’s Ninetieth Birthday,” November 8, 2002
Bernanke concluded his 2002 speech:
“Let me end my talk by abusing slightly my status as an official representative of the Federal Reserve. I would like to say to Milton and Anna: Regarding the Great Depression. You’re right, we did it. We’re very sorry. But thanks to you, we won’t do it again.”
He went and did it, with Dr. Bernanke the (now wealthier) standard-bearer of history’s most disastrously flawed economic ideology. Bernanke: “[NY Fed president Benjamin] Strong died from tuberculosis early in 1928, and the Fed passed into the control of a coterie of aggressive bubble-poppers…” Worse yet, the former Fed chair believes the tragedy of the Great Depression would have been avoided had the Fed printed money to recapitalize the U.S. banking system.
“Roaring Twenties” excesses were not the problem. Credit and speculative Bubbles that emerged from the First World War (and nurtured by the fledging Federal Reserve) do not factor into his analysis. And market and economic structures that evolved over years of loose financial conditions are irrelevant. Simply point blame to Fed incompetence (for not inflating), along with the gold standard.
We’re already seeing evidence of the failure of Bernanke-style central bank inflationism. The Bank of England’s printing press has to somehow perform as buyer of last resort for a collapsing bond market Bubble, while also reining in inflation. Bernanke ridiculed the Bank of Japan until they finally succumbed to egregious money printing. The resulting debacle is at the cusp of being exposed.
Yet there’s an even more historic experiment in Bernanke inflationism that continues to unfold in China. The money and Credit floodgate is propped wide open. And Beijing will surely recapitalize its massively bloated banking system as they see fit. But will ongoing monetary inflation forestall Bubble collapses? Of course not. Will avoiding bank runs prove decisive in sustaining China’s boom cycle?
Bank runs or not, China’s Credit system is on an unsustainable course. It’s nothing short of epic “Terminal Phase Excess” – with massive Credit growth of rapidly deteriorating quality feeding exponential growth in systemic risk.
China’s September growth in Aggregate Financing jumped to a much stronger-than-expected $490 billion, up from August’s $340 billion and 22% ahead of September 2021 ($404bn) – to a record $46.9 TN. Year-to-date growth of $3.85 TN is about 12% above comparable 2021 – and only 6.5% below 2020’s historic Credit onslaught. Aggregate Financing posted 10.5% one-year growth, perilously racing ahead as the deeply maladjusted Chinese economy stagnates. Recipe for currency crisis.
Bank Loans expanded $344 billion, rising from August’s $174 billion and almost 50% ahead of September 2021 ($230bn). Year-to-date Loan growth of $2.51 TN is 8% ahead of comparable 2021 and 11% above 2020.
Corporate Loans surged $267 billion, double both August and September 2021. At $2.01 TN, y-t-d growth is running 39% ahead of comparable 2021. Year-over-year growth rose to 13.4%, the strongest pace since February 2016. Corporate Loans expanded 26.3% over two years, 41.9% over three, and 73.9% over five years.
Consumer Loans expanded $90 billion, up from August’s $64 billion, while still 18% below September 2021. Year-to-date growth of $474 billion is 46% below comparable 2021 and 44% below 2020. One-year growth of 7.2% is the weakest in data back to 2007. A historic consumer (chiefly mortgage) lending boom has faltered, with two-year growth slowing to 21%, three-year to 39%, five-year to 91%, and 10-year growth to 380%.
Government Bonds increased $78 billion during September, up from August’s $42 billion, but down from the year ago $111 billion. Y-t-d growth of $823 billion was 35% ahead of comparable 2021, and only 12% below 2020’s record issuance. Government bonds expanded 16.9% over one year, 32.7% over two, and 59% over three years.
China’s stocks rallied, yet it was an ominous week for Chinese finance. An index of Chinese dollar developer bonds dropped to a record low (yield up to 26.8%). Evergrande yields surged 40 percentage points to 227%. Country Garden yields jumped 13 percentage points to a record 66.5%. Sunac yields rose 26 percentage points (135%), Lonfor 28 percentage points (148%), and Kaisa 38 percentage points (187%).
Indicative of escalating systemic risk, Chinese bank CDS jumped to multi-year highs. China Construction Bank rose 13 to 143 bps; Industrial and Commercial Bank 12 to 137 bps; Bank of China 10 to 136 bps; and China Development Bank 12 to 126 bps. “AMC” China Huarong CDS jumped 41 to 635 bps (began the year at 261bps). China sovereign CDS traded up to 115 bps Thursday, the high since early-2017. The renminbi lost 1.1% versus the dollar, trading near the low back to 2008.
Meanwhile, Italian 10-year yields rose nine to 4.79%, closing the week at the highest yield since 2012. Japanese 10-year JGB yields are at the BOJ’s 25 bps ceiling, while the yen sank another 2.3% (down 22.6% y-t-d) to 30-year lows. Vulnerable EM bonds were under intense pressure. Yields surged 128 bps in Colombia (14.36%), 74 bps in Hungary (10.66%), 54 bps in Romania (9.05%), 38 bps in Czech Republic (5.48%), and 37 bps in Poland (7.69%). Yields were up 19 bps in both Mexico (9.83%) and South Africa (11.27%).
The dominoes are aligning for a major synchronized global market crisis.
October 12 – Financial Times (Laura Noonan): “The Bank of England has said ‘lessons must be learned’ from the pensions crisis that triggered an unprecedented intervention in the UK gilt markets, and stressed the need for action to mitigate similar risks in other parts of the financial sector. ‘While it might not be reasonable to expect market participants to insure against all extreme market outcomes, it is important that lessons are learned from this episode and appropriate levels of resilience ensured,’ the BoE’s financial policy committee said… The BoE also warned that UK households and companies were under strain as high interest rates, high energy costs and the cost of living crisis combined to make it harder for them to pay bills and loans. Mortgages were a particular concern, with the bank warning that household debt levels could hit historic highs.”
The UK is a microcosm. Lessons will finally be learned – but it will be the hard way.