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. 

BSP’s Interest Rate Primer: Low Rates Are the Cause of Inflation! BSP Rate Hikes: Peso, Treasuries, and Stocks Plunge

 Neither have capital or capital goods in themselves the power to raise the productivity of natural resources and of human labor. Only if the fruits of saving are wisely employed or invested, do they increase the output per unit of the input of natural resources and of labor. If this is not the case, they are dissipated or wasted—Ludwig von Mises 

 

In this issue 

BSP’s Interest Rate Primer: Low Rates Are the Cause of Inflation! BSP Rate Hikes: Peso, Treasuries, and Stocks Plunge 

I. Surprise! BSP’s Interest Rate Primer: Extended Low Interest Rates Are the Cause of Inflation! 

II. BSP Hikes Ignored: Most Treasury Yields Surge 

III. BSP Hikes Ignored: USD Peso Soared to Fresh All-Time Highs! 

IV. PSEi 30 Plummets to July Lows as Stagflationary Forces Spreads! 

 

BSP’s Interest Rate Primer: Low Rates Are the Cause of Inflation! BSP Rate Hikes: Peso, Treasuries, and Stocks Plunge 

I. Surprise! BSP’s Interest Rate Primer: Extended Low Interest Rates Are the Cause of Inflation!  

Figure 1 

 

Surprise!  

 

The BSP has an important revelation. In their primer of "Why Should Interest Interest You," they actually state that Having very low interest rates for a long time can cause INFLATION.  (BSP, 2022) [figure 1, topmost pane] 

 

See?  The root of inflation is artificially lowered rates!  

 

But the public barely knows of this position by the BSP.  This media literature on "financial inclusion and consumer protection" is camouflaged with the avalanche of many other materials. 

 

To begin with, the BSP misattributes money as a "second-round" effect of the recent perturbation from price pressures. 

 

After raising rates by another 50 bps last week, they explained: With less money going around and demand for goods and services diminished, prices are expected to go down. “In deciding to raise the policy rate anew, the Monetary Board noted that price pressures continue to broaden,” Dakila said. “Moreover, second-round effects continue to manifest, with inflation expectations remaining elevated in September following the approved minimum wage and transport fare increases,” he added. (Inquirer, 2022) 

 

No.  Supply-side disruptions do raise the prices of certain goods and services.  But because of the scarcity of purchasing power of individuals, prices of other goods and services should fall; in the condition that the money supply is stable and markets are allowed to clear.  But that has not been the case.  The BSP continues with its thrust to use liquidity to generate GDP.  Ergo, too much money chased too few goods. 

 

But here is the thing.  For the longest time, the BSP has pursued a "zero-bound rate" strategy as part of its precept of "inflation targeting" for the goal of "price stability." (BSP, 2020) 

 

The pandemic justified the intensification of its use.  Policy rates dived to an all-time low of 2%.  The BSP mimicked a global central bank trend of policy activism. 

 

Yet, their data also reveals that while money supply growth has trended higher over the years, it exploded from Q4 2019 to a new milestone in 2021 and has hovered around this area. 

 

The increase in the money supply relative to the GDP tell us that the BSP imposed on the economy the zero-bound policy to promote "financialization."  Or it used monetary policy and liquidity measures to advance the interests of the government and the banking and financial industry through the acceleration of credit expansion. 

 

The GDP is now entirely dependent on the sustained growth of the money supply. 

 

The Keynesian ideology of attaining economic utopia from unfettered spending is the foundation for such policies.  

 

Because such policy ignores the ramifications of the distribution of resource allocation, the importance of time, opportunity costs, balance sheet conditions, and the function of the entrepreneur, the backlash from it emerges over time. 

 

Or, its effects are asymmetric and intertemporal.  The distribution benefits some segments, but most don't.  And the consequences occur across time or are time-lagged from their imposition. 

 

For instance, the initial phase of such measures triggers a boom.  Because of this, the public embraces the easy money policy as "sustainable," which they attribute to the "competence" of the central bank. 

 

The problem is:  Imbalances from such policies accrue, such that once it reaches a tipping point, disorderly adjustments are the consequences.  

 

Today's problems are the manifestations of the excesses of interventionist policies. 

 

The evidence is everywhere. 

 

And as pointed out last week, the diffusion of liquidity from election spending and increases in consumer leveraging in the banking system resulted in a pronounced boost in food retailers' sales in the 1H 2022.   

 

Meanwhile, the non-food retail sector exhibited modest improvements.  

 

In any case, the boost in demand, which may reflect price hikes more than volume, signified a first-order effect.  

 

But authorities would not permit the public to know this.  Instead, they passed the blame onto the supply side.  They hope to sustain their unsustainable model of a GDP driven by public spending financed by debt and the inflation tax. It likewise hopes that the credit-dependent bubble sectors complement its agenda. 

 

At any rate, the latest increase in policy rates has barely alleviated the apprehensions of the domestic financial markets.   

 

Nevertheless, the consensus experts have, in near unanimity, laid the burden on the US Federal Reserve. 

II. BSP Hikes Ignored: Most Treasury Yields Surge 

 

Figure 2 

Technically, the BSP narrowed the difference between its policy rate (4.25%) and the official CPI (6.3%). But its spread remains "negative," coming off its milestone gap. (Figure 1, lowest pane) 

 

The official CPI should not be seen as static (even as political agenda seems to dictate its calculations).  

 

In this regard, the domestic financial markets respond to it. 

 

Last week's hike seems to have been ignored by institutional treasury traders.  Most of the T-Bills and T-Bonds yields soared this week. (Figure 2, left topmost pane) 

 

With traders seemingly unconvinced, the 10-year and BSP ON RRP (official rate) spread barely came down.  (Figure 2, right topmost window) 

 

In Asia, the yield of the 10-year Philippine Treasury was the third fastest gainer after Vietnam and South Korea. (Figure 1, middle pane) 

 

And while its spread against the UST counterpart was almost unchanged from last week.   The local bond yields have risen faster than its UST peer since 2021.  

 

The faster yield increase in domestic treasuries is a problem of the US Fed? 

 

III. BSP Hikes Ignored: USD Peso Soared to Fresh All-Time Highs! 

 

Figure 3 

 

Once again, the USD Php closed the week at 58.5 a fresh high. (Figure 3, left topmost window) 

 

Like their treasury peers, currency traders likewise glossed over the move of the BSP.   

  

Suddenly, the consensus experts have been piling upon each other to "forecast" the USD at Php 60 and above.  They are the experts of momentum. They chase a trend in fashion.  

 

A bank commented that investors have started to rotate out of the peso and into USD financial products. But this is to be expected. The FX deposits share of bank liabilities has dramatically risen since Q1 2021. However, they seem to have noticed it only now. (Figure 3, lowest pane) 

 

The USD-Peso was this week's third-best performer after the USD-Yuan and the Thai baht. 

 

Sure, authorities label the USD Php as "middle of the pack," but that would be comparing the problems of advanced economies, likewise suffering from the backlash of heavy indebtedness.  

 

But if this is true, why has the Indonesian rupiah been the outlier? What has made the rupiah seemingly immune to the "strong dollar" problem? 

 

Such "appeal to the majority" rationalizations constitute the sentiment of the consensus, who never saw this coming.  

 

We have argued way back that the Other Reserve Assets (ORA), or derivatives and public borrowings that comprised the record buildup of the GIR, thereby signified the "USD shorts." 

 

Since these borrowings require repayments, are these reserves not only artificial and temporary but represent USD shorts? That is, shorts as in “the mismatch (maturity) between short-term interbank borrowing (globally) on the liability side supporting and maintaining longer duration loan or security assets”… 

  

The bigger their USD liabilities, the more prone the BSP is to a squeeze. (Prudent Investor, 2020) 

 

It does not help when authorities use gaslighting to assuage the public from reality. 

 

In all these cases, the problem is never that the dollar is "too strong." The problem is that other central banks are even worse, and that depreciation of other currencies are causing instability, lost wealth, and economic crises. (McMaken, 2022) 

 

IV. PSEi 30 Plummets to July Lows as Stagflationary Forces Spreads! 

 

 

Figure 4 

 

The PSEi 30 tumbled by another 4.42% this week, its fifth weekly decline for an aggregate 8.8% markdown.  The PSEi 30 is back at its July levels.  

 

Along with Hong Kong's Hang Seng Index (-4.42%), the PSEi 30 plunge vitiated weekly returns of Asian equities by 1.29%, despite the 11.84% surge of the equity bellwether of Laos. 

 

The PSEi 30 tumbled by another 4.42% this week, its fifth weekly decline for an aggregate 8.8% markdown.  The Sy Group skewed the PSEi 30 is back at its July levels.  

 

Interestingly while global banks have taken a thrashing, shares of domestic banks had been least affected (-2.57%), even as its main client, the property sector (-7.18%), bore the brunt of the selldown. 

 

Global equity markets, including the PSEi 30, seem oversold and may be due for a rebound.   But in bear markets, oversold markets can remain oversold for an extended period. 

 

As a reminder, we are in an inflationary bear market, an episode not seen since the 70s.   

 

As it is, as stagflationary conditions spread, the risk of something breaking and causing a contagion from the present fragile global and domestic conditions only crescendoes.   

 

Or, 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. 

 

Be careful out there. 

 

___ 

 

References: 

 

BSP Media and Research, "Why Should Interest Interest You," (2022) bsp.gov.ph 

 

BSP Media and Research, Inflation Targeting, March 2020 bsp.gov.ph 

 

Inquirer.net, BSP again raises rates by 0.5 ppt to quell stubborn inflation, September 23, 2022 

Prudent Investor BSP’s April 2020 FSR: PSE’s Soaring Debt-at-Risk, Bank and Financial Vulnerabilities, Risks of Re-Fitting of the Economy and More… June 28, 2020 

 

McMaken, Ryan, Central Bankers Are Gaslighting Us about the "Strong Dollar", September 20, Mises.org