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.
