By Michael Every of Rabobank
"This is the Way" to Lehman, bubbles, or MMT
Yesterday saw more *wild* market action.
It started with a key Tory official arguing not with the EU, but markets (“Tory Peer Lord Frost Doesn't Think 'Anything Has Gone Wrong' As Pound Touches Record Low: The former chief Brexit negotiator dismisses market turmoil since the mini-budget as “unwarranted” and an “over-reaction) while Tory supporters argued on social media with the IMF (“Embarrassed for the IMF. This is the IMF self-declaring as a left-wing body. The UK should now withhold its IMF contributions.”)
There were rumors, long heard on the Street, that Janet Yellen is out as Treasury Secretary after the mid-term elections. Who, without a key role at present, has been all over the press talking about the need for higher rates? Larry Summers. So who is next in line, perhaps? What a shock for markets that would be. From someone who once ran the Fed to someone who wanted to run the Fed. How apt given the increased link-up between fiscal and monetary policy.
While GBP was around 1.07, EUR was at 0.9550, CNY at 7.23, AUD below 0.64, and NZD lower than it’s Covid trough. In bonds, Europe --which sadly cannot keep burning Angela Merkel’s reputation for heat forever-- heard the ECB’s Holzmann hold up the UK up as an example of how he would carry out QT - like ripping a plaster off a wound.
Pension funds long Gilts were getting crushed, with the 30-year yield at 5.10%, and a spiral of events beginning that threatened an imminent Lehman-like event (as Yellen told us would never happen again in her lifetime: just don’t mention what FRA-OIS spreads are doing again).
Then the BOE announced it would buy unlimited long Gilts, which is now apparently to be GBP5bn a day for 13 days, just ahead of when it was supposed to be selling them, to prevent “a material risk to UK financial stability”.
Down went UK long yields, the 30-year closing at 3.93%; down went yields everywhere – the US 10-year was at 4% yesterday morning and went straight back to 3.75% (potentially blowing up anyone who was short); and up went global equities.
After all, if the BOE could U-turn, surely the ECB and the Fed could too? Indeed, earlier in the day, the ECB’s Lagarde did not make it entirely clear to all listeners whether she was a buyer or a seller of bonds, or both, when she spoke around the issue and her long list of pet acronyms.
For those not paying attention, what we just got was something I believe only this Daily has been flagging all year (but do please correct me if I am wrong on that claim) – QE and rate hikes.
Of course, as a colleague pointed out, it was not the MMT plus rate hikes I have been saying is inevitable, because the BOE action was “not intended to be useful”: ironically, the budget behind the extra Gilt issuance also isn’t useful. Yet the BOE action was useful for markets, as there were no other buyers at that point. It was therefore an emergency pension fund bailout.
The market reaction shows they think “This is the Way”. Watch everyone start saying QE and rate hikes can work together, and expecting their own bailouts. I will be in the corner wishing I had printed T-shirts saying “QE + rate hikes”, like the “DM = EM” ones I also didn’t make, and which I would not have accepted sterling for if I had. (Sorry, dollars only.)
Yet the problems with assuming we are now ‘saved’ are:
- We just saw another huge easing of financial conditions that means central banks need to raise rates even more - and they are determined to do so. As Bloomberg reports today, “Some big bond investors say don’t be deceived by the Treasury market’s torrid rally Wednesday. The hawkish signals still coming out of the Federal Reserve are what matters. The rest is noise.” Indeed, otherwise there is no point in inflation targeting and independent central banks at all.
- The market will smash currencies of those doing QE. While GBP closed higher despite the BOE de facto paying for rich people to buy more stuff(!), the DXY dollar index collapsed on the mere idea that the Fed might start doing QE again too. That is as the US leans on a strong dollar to suppress inflation
- Brent leaped 3.5% on the day even as physical demand is faltering and recession looms, while Bitcoin and gold leaped too. This is the yields-down-so-commodities-up *SO YIELDS ARE WRONG* argument I have been making this year.
- Central banks won’t watch a systemic crisis unfold (and Summers being quoted on Bloomberg as backing the BOE move only underlines that he is likely to fill Yellen’s shoes) but large market losses as they raise rates are clearly fine in their/his eyes. It may not be “Liquidate labour, liquidate stocks, liquidate the farmers, liquidate real estate”, but there must still be a lot of liquidation, or else we can’t remove inflation now supply chains are “geopolitical” and workers are “political”.
I stand by my view that MMT plus rate hikes will be “the Way” because there is nothing else on the table. Unless we want to go back to bubbles, which the market clearly does because that is all it does. (As another colleague yesterday quipped, people who think they are a solution to our problems also think we can house the homeless in the Metaverse.)
Emergency actions aside, on QE vs. MMT, the BOE’s actions wouldn’t be bubble-blowing if it bought bonds from the government directly, not the secondary market. That way there would be no lower yields except in as much as the total bond supply hitting the market is partly absorbed. That would also force differential borrowing costs within the economy to reallocate resources to the supply side: the state borrows for free to do so, the private sector borrows at whatever the non-emergency bond yield is plus the usual spread to do what it wants to do.
Part of the “QE is not MMT” argument also rests on a view QT will soon reverse QE: but can that really happen now? The BOE just cancelled a speech on balance sheet contraction pencilled in for today. But if so then the imperative must surely be NOT to do more of the same old QE, when everyone can see what vast nothingness its trillions of dollars have bought us in our unequal, inflation-struck, and geopolitically-unprepared real economy?
To hammer that home, ask critics of the UK what they would do instead. “Not this” is not a policy. Watch the realisation slowly sink in that there is nothing that logically could be done from here BUT rate hikes and supply-side MMT. Apart from just suffering for years.
Meanwhile, China and UK both just said “This is NOT the Way” via warnings to speculators not to bet against their currencies. In neither case will this work while the dollar is still going up, which it soon will be again - especially with Summers in the background. Yet that parallel warning makes sense given both economies are likely going to end up with similar MMT-led supply-side policies… once all the others have been tried and failed. After all, Bloomberg reports today that the likely next China ‘economic czar’ will be He Lifeng, who favours more credit and more growth, which will likely mean de facto MMT either on or off book. Which, by the way, will be hugely inflationary for everyone from the commodity side.
So, don’t think the volatility is over yet: vastly more lies ahead. Especially since the word is the British government absolutely refuses to accept that this is a crisis, or driven by its own actions in any way, or is something that the general public is either noticing or worried about(!)