Month: September 2022

UK pension funds are/have been servicing ever increasing margin calls driven by the extreme moves in real and nominal rates.

As BondVigilantes.com notes, they are on a hunt for liquidity (cash) to service these calls at the same time the liquidity (bid offer spread) of asset markets is extremely fragile. A sub layer to this dynamic is that pension funds are also a significant provider of gilts to the repo market (which they repo out to fund levered investments) and where we are now seeing some strain as these gilts are either withdrawn from repo programmes (to sell, as of yesterday to the BOE) or repo’d out to raise cash to fund said margin calls.

The timing could not be worse with quarter end looming, increasing demand for bank balance sheet from non-bank market participants and an ever increasing war chest of cash from the liquidity ‘Haves’ chasing collateral.

While The Bank of England stepped in to buy gilts on Wednesday, stabilising the market, The Financial Times reports that the pension funds are continuing to sell assets to meet cash calls.

“There’s a lot of pain out there, a lot of forced selling,” said Ariel Bezalel, fund manager at Jupiter.

“People who are getting margin called are having to sell what they can rather than what they would like to.”

He said the BoE’s intervention had helped to bring down yields in longer-dated bonds but other assets remained “under pressure” because pension schemes were “having to liquidate paper”. He added:

“We’re seeing really quality investment grade paper coming up for grabs…names like Heathrow, John Lewis, Gatwick, BT – solid fundamentals – to raise cash.”

Simeon Willis, partner at XPS Pensions Group, said:

“Pension schemes are selling equities and corporate bonds and using those assets to top up their hedges.”

“There could be many hundreds of schemes that have had their hedges reduced or removed. This means their funding positions are now much more vulnerable than they were a week ago.”

To fund the collateral calls, some pension schemes have resorted to asking employers backing their plans for cash. Outsourcing group Serco provided £60mn after a request from pension trustees, according to a person familiar with the matter, a highly unusual move for a well-funded corporate scheme. Sky News first reported the move.

While some schemes continue to rush to raise cash to fund their derivatives positions, others have had the positions terminated by LDI managers, including BlackRock, leaving them exposed to further moves in rates and inflation.

Related to this liquidation, more behind-the scenes details of this week’s chaos in the UK are being exposed with The FT reporting that none other virtue-signaler-extraordinaire BlackRock basically ‘blackmailed’ the UK government into intervention as UK pension funds faced crises.

BlackRock, which sits between the pension schemes and banks on derivatives trades designed to hedge against adverse movement in interest rates and inflation, told its clients that it would no longer demand additional collateral but would instead liquidate holdings to meet margin calls that were soaring due to the extreme volatility in UK asset prices.

In a memo sent on Wednesday morning, BlackRock told clients using its liability-driven investing strategies that it would freeze “funds more at risk of assets being exhausted” and move the assets to cash.

The graph below shows the overall market value of available gilt collateral has fallen sharply over recent days…

BlackRock is “not proceeding with any further recapitalization events until further notice”, said the email to LDI clients, which was seen by the Financial Times and was sent at about 11am, before the Bank of England announced its emergency intervention to stabilise the gilt market.

David Fogarty, a professional trustee with Dalriada, a trustee firm, said:

“If you run out of collateral they were saying, ‘we will close the position’, without going back to ask for more money from the fund. It is protecting their positions against contagion but it is not protecting their pension funds.”

This liquidation would have caused even further vicious spiral plunges in gilt prices and, just as JPMorgan did in 2019 with The Fed and ‘Not QE’ to bailout the repo market, BlackRock exercised its ‘TBTF Put’ and forced The Bank of England’s hand to re-liquify the long-end of the gilts market.

In summary, as BondVigilantes.com notes, there are very clear collateral strains for some sterling market participants and demarcation of the liquidity ‘Have and Have Nots’. The urgent question (with an unclear answer at the moment in my view) is whether this could spill over into a broader liquidity breakdown as the various actors seek to right-size or further shore up their defensive cash stocks during these unprecedented markets. One thing that goes without saying is that cash really is king at the moment.

Authored by Michael Maharrey via SchffGold.com,

If the Keynesians are right, Hurricane Ian will create an economic boom here in Florida. After all, breaking windows creates demand and that stimulates the economy. And after this massive hurricane cut through Florida, there were a lot of broken windows — and much worse.

Now, you might be wondering what in the world I’m talking about. How does breaking windows create an economic boom?

I’m referring to the “broken window fallacy” first explained by French economist Frédéric Bastiat. And at some point in the next few weeks, more than one economist will try to put a positive spon on the destruction by claiming it will create economic activity. This is yet another common fallacy we run into whenever their is a disaster, right along with the hand-wringing over price gouging.

Imagine that somebody throws a rock through a shop window. Many economists will argue that’s good for the economy because the shop owner will have to pay the window fixer to repair the window. As Bastiat put it in his essay, “If you have been present at such a scene, you will most assuredly bear witness to the fact, that every one of the spectators, were there even thirty of them, by common consent apparently, offered the unfortunate owner this invariable consolation: ‘It is an ill wind that blows nobody good. Everybody must live, and what would become of the glaziers if panes of glass were never broken?’

You see, the shopowner’s misfortune is the glass fixer’s good luck.

With the money he makes fixing the window, the glazier can go buy a new suit. The tailor will then have money in his pocket to go to a baseball game. The owner of the baseball team benefits from another fan in the seats, and on and on it goes. The broken window led to a string of economic transactions. As Bastiat put it, the careless child “spurred trade to the amount of six francs.”

On the surface, it does seem as if the broken window led to a small economic boom. But when you dig below the surface, it becomes clear that the boom is a mirage.

But if, on the other hand, you come to the conclusion, as is too often the case, that it is a good thing to break windows, that it causes money to circulate, and that the encouragement of industry in general will be the result of it, you will oblige me to call out, ‘Stop there! Your theory is confined to that which is seen; it takes no account of that which is not seen.’”

What have we missed?

We don’t see the money that was never spent.

If the shopkeeper hadn’t had to spend 6 francs on a new window, he would have bought a pair of shoes. Now, that transaction won’t happen and the cobbler won’t receive that income. As a result, the cobbler will have to postpone buying a new book for his library.

Bastiat sums it up this way.

Let us take a view of industry in general, as affected by this circumstance. The window being broken, the glazier’s trade is encouraged to the amount of six francs: this is that which is seen.

“If the window had not been broken, the shoemaker’s trade (or some other) would have been encouraged to the amount of six francs: this is that which is not seen.”

A good economist always tried to account for the unseen. But sadly, most people aren’t good economists — and that includes a lot of economists.

It should be clear breaking a window does not make society better off. It becomes even more clear when you magnify the destruction to the level produced by Hurricane Ian. Yes, billions will be spent to repair and clean up. Roofers, builders and others will make a lot of money. But you have to stop and consider the cost to others. I doubt anybody in Ft. Meyers will claim they’re better off because their house lost a roof or filled up with water. And just stop and imagine whould would have been done with those billions had the hurricane never materialized.

Destruction isn’t progress. This is just silly, Keynesian claptrap.

Never forget the unseen.

How bad is it out there? So bad Americans can’t even afford to rent any more, or as Biden would put it: “the strongest economic recovery in recent history.”

My first two years in office spurred the strongest economic recovery in recent history. Today, I’m releasing my Economic Blueprint, a look at how our wins are rebuilding an economy that works for working families.https://t.co/eSlr3ymdo8

It’s long. So here are the big things:

— President Biden (@POTUS) September 9, 2022

In addition to the previously discussed implosion at Nike, whose stock is getting crushed by the bullwhip effect sending inventories soaring as US consumers hit a recession brick wall, a middle-American staple is getting hammered even harder: yes, Rent-A-Center is down as much as 20% today…

… one of its biggest one-day drops on record, which has pushed the stock back to April 2020 levels.

What happened? Well, the floor fell out after the rent-to-own store chain operator’s adj. EPS forecast for the third quarter fell far short of analyst estimates, lowered Q3 guidance citing macroeconomic headwinds – which impacted retail traffic and customer payment behavior – and most ominously, the company didn’t reaffirm its 2022 guidance, prompting brokers to cut their targets on the stock.

Some details:

• RCII expects Q3 adj. EPS of $0.85-$0.95, missing consensus estimate of $1.16. Its prior outlook was $1.05-$1.25.
• Q3 revenue is projected to be $1B-$1.02B vs. consensus estimate of $1.03B. Its earlier forecast was $1B-$1.055B.

Oh yeah, and the CFO just quit.

Commenting on the disastrous results driven by a collapse in demand, RCII CEO Mitch Fadel said “external economic conditions continued to deteriorate over the past few months… recent inflationary conditions have been especially challenging for customers.” Or, again, as Biden would say: “the strongest economic recovery in recent history.”

The Company said it was not updating or reaffirming its previously reported consolidated guidance for the full year 2022, and will provide an update on the fourth quarter 2022 with its earnings announcement that is expected in early November.

• “External economic conditions have continued to deteriorate over the past few months,” said Mr. Fadel.
• “This has affected both retail traffic and customer payment behavior, so we are updating third quarter guidance to reflect the impact of those trends on our business.”

Translation: Americans can’t even afford to rent stuff any more, let alone buy.

And like in the case of Nike, sellside research was shocked:

KeyBanc (overweight, cuts PT to $37 from $41)

• Analyst Bradley Thomas is “disappointed” by the degree of near-term challenges at RCII, though notes that they do align with weakness seen in some of co.’s channels
• While analyst continues to see near-term risks, believes RCII’s Acima segment can benefit from long-term secular growth trends

Janney (buy, PT cut to $44 from $52)

• Given RCII’s management did not reaffirm 2022 guidance, the clear indication is that it will be cut when they report 3Q22 EPS, analyst John Rowan says
• While the announcement is “disappointing,” the stock is undervalued

What happens next? Why those same lower/middle consumers who can’t even afford to rent stuff due to soaring prices, are about to lose their jobs too as the Fed and the puppet Biden regime push the US economy into all-out collapse.

Via Global Macro Monitor,

The Great Reset is upon us. 

All things as we have known and have become comfortably numb with, such as zero interest rates, negative real interest rates, quantitative easing (digital money printing), and Pax Americana, [and central bank dominance of the U.S. bond market] are being upended and overturned.  Beware of recency bias, folks, as the global structural shifts and changes are now ubiquitous. – GMM, Sep 23rd

Here’s a quick primer that may explain the current global macro dynamic between the strong dollar and rising bond yields. We’ve been beating this drum for years.

Central Banks Will Be Net Sellers Of Treasury Securities

Central banks, both foreign and the Fed, who are and have never been price and market sensitive, have been the predominant buyers of Treasury coupon securities over the past 20 years. 

Look at the following table from a July 2021 post, which set the stage for the inflation we are now experiencing. 

Granted, the massive ramp in the budget deficit during COVID – to a 12-month trailing high of 19 percent of GDP in March 2021 – is unlikely to repeat, but ditto for the Fed’s Treasury purchases.  The markets did not have the ability to absorb such a massive new issuance without a major financial disruption and a spike in interest rates. 

The markets will now have to absorb or step in and replace both the Fed’s demand as the balance sheet runs off (effective net Treasury selling) and the foreign central bank selling. Both have now morphed from the largest buyers to net sellers.

Also, note from the above table the Fed’s purchase of almost 200 percent of TIPs issuance during the period; that is, all of it and then some.  Inflation expectations?  Managed!

China Selling Treasury Holdings

Once the largest foreign holder of U.S. Treasury securities, China has sold down its holdings by over 26 percent from its November 2013 peak.  We also have no doubt Japan’s holdings are down from the latest observation in July. However, the Bank of Japan (BoJ) seems more comfortable with a weakening yen but not at the recent rapid clip, which forced them to intervene in the currency market. 

Japan intervened in the foreign exchange market on Thursday to buy yen for the first time since 1998, in an attempt to shore up the battered currency after the Bank of Japan stuck with ultra-low interest rates.   –  Reuters, Sep 22nd

  

Global Capital Flows And The Great Financial Crisis

Before the Great Financial Crisis (GFC), the Fed raised its policy rate by 425 basis points, and long-term yields barely budged.  Were financial markets efficient in anticipating the GFC?  

Hardly.  The technical position of the yield curve contributed to and helped cause the GFC.

Alan Greenspan argued that the Fed lost control of the U.S. yield curve. Foreign central banks recycled their massive dollar purchases back into the U.S. bond market after intervening in home markets to keep their currencies from appreciating.  Central banks were still reeling from the 1997 Asian Financial Crisis, which taught them a hard lesson about letting currencies become too overvalued.    

The foreign central bank Treasury purchases suppressed long-term rates and allowed the credit and housing bubble to continue for much longer than the Fed anticipated and desired.  

Looking back, he [Alan Greenspan] says today: “We tried in 2004 to move long-term rates higher in order to get mortgage interest rates up and take some of the fizz out of the housing market. But we failed.” Something besides Fed policy was at work. Both Mr. Greenspan and his successor, Ben Bernanke, point to an unanticipated surge in capital pouring into the U.S. from overseas. – Council of Foreign Relations

Are We Now In A Rising Bond Yield/Strong Dollar Feedback Loop?

In our 2017 post, Orwellian Monetary Policy, we posited that tighter domestic monetary policy in a globalized capital market could, in effect, and paradoxically, create looser domestic financial conditions as foreign capital is sucked back into the U.S. markets.  We suspect that is what happened before the GFC and agree with Greenspan and Bernake on this point. 

We wrote in the dystopian 1984 language, 

“Tightening is Easing”

Today’s World

The moves in exchange and interest rates over the past few months have been violent.

We suspect we are now in a bond yield-dollar feedback loop, where many central banks are forced to intervene in their home currency markets, selling their Treasury holdings to raise the dollars to ease the pressure on the home currency.

On the margin – and prices are set by marginal buyers and sellers — their actions put downward pressure on U.S. bond prices, causing yields to rise.  

We are unsure whether this is a reality or GMM fitting reality to a nice theory, but we deduce it fits the action we are currently witnessing in the global markets. 

The same is true for all central banks whose currencies are under pressure.  Witness the positive feedback loop.

Reflexivity

Reflexivity in economics is the theory that a feedback loop exists in which investors’ perceptions affect economic fundamentals, which in turn changes investor perception. The theory of reflexivity has its roots in sociology, but in the world of economics and finance, its primary proponent is George Soros. – Invetopedia

We don’t know if the markets are in a period of Soros’ reflexivity, where traders and investors understand the above model and are trading on it, causing yields to rise and the dollar to strengthen even further in a self-fulfilling prophecy. 

We suspect it is so; in the same spirit of Milton Friedman’s pool player analogy, acting as if they understand the laws of physics even though they don’t. 

Consider the problem of predicting the shots made by an expert billiard player. It seems not at all unreasonable that excellent predictions would be yielded by the hypothesis that the billiard player made his shots as if he knew the complicated mathematical formulas that would give the optimum directions of travel, could estimate accurately by eye the angles, etc., describing the location of the balls, could make lightning calculations from the formulas, and could then make the balls travel in the direction indicated by the formulas. Our confidence in this hypothesis is not based on the belief that billiard players, even expert ones, can or do go through the process described; it derives rather from the belief that, unless in some way or other they were capable of reaching essentially the same result, they would not in fact be expert billiard players. – Milton Friedman, Essays in Positive Economic, 1953

Where Are The Dollars Going?

Moreover, where is all the liquidity going from the King-Kong dollar strength?  

Our priors are more, or some are being transferred from foreign central bank holdings of Treasuries into private sector hands and recycled back into the U.S. short-end bond and money markets.  

Nobody knows for sure, but after three 75 bps rate hikes and quantitative tightening well underway,  one would think that money liquidity would be shrinking.   However, it doesn’t seem to be the case as the Fed’s overnight reverse repo facility remains at record highs. 

We suspect foreign capital is flowing into the short-end, which now provides decent yields of 3-4 percent, giving the gorilla strength to the U.S. dollar. 

Are Financial Conditions Tight?  

After the jumbo rate hikes and $90 billion per month being drained from the domestic financial markets as the notes and bonds roll off the Fed’s balance sheet, one would think so. 

Our favorite indicator of U.S. financial conditions,, the Chicago Fed’s National Financial Condition Index (NFCI), a weighted average of a large number of variables (105 measures of financial activity). tells a different story, however.   Financial conditions remain slightly loose. 

Upshot

The U.S. financial markets are still flush with too much money, and the Fed has once again lost control of events. Something big will eventually break, but in the words of the great-late MIT professor Rudy Dornbush,

In economics, things take longer to happen than you think they will, and then they happen faster than you thought they could. – Rudiger Dornbusch

Because we have reached the tipping point of excess money, liquidity, capital, or however you define it, which are creating global inflationary pressures, don’t count on the monetary cavalry coming to the rescue anytime soon or returning to the good old days of hurricane force central bank headwinds.

Look how markets reacted to the U.K.’s unfunded tax cuts this week. 

Britain’s new government announced a sweeping series of tax cuts on Friday, betting it had found the path to economic growth despite high inflation.

But the market verdict was swift and negative: The value of British stocks and bonds fell sharply, while the pound sank to lows against the U.S. dollar not seen since 1985. – NY Times

The Great Reset is upon us, folks.  Don’t fight it. 

We expect global policymakers will eventually be forced to coordinate their actions.  

Ukraine’s government has responded to Russia’s formal annexation of the four eastern and southern regions of Luhansk, Donetsk, Kherson and Zaporizhzhia on Friday by saying it has applied to become a member of the NATO military alliance.

President Volodymyr Zelensky has announced his country is submitting an “accelerated” application to formally join NATO. This could mark a huge escalation and turning point in the war, largely dependent on NATO leadership’s response, given the question of NATO expansion right up to Russia’s border remains a central motive in the Kremlin launching and continuing the invasion.

Of course, looming large over Brussels is the fact that based on Article 5, any acceptance of Ukraine into NATO would automatically trigger a Russia-West world war, and follows increasing nuclear rhetoric out of Moscow.

Zelensky was quick to put out a response to Putin’s major Friday speech wherein he referred to Ukraine as already a de facto part of NATO, saying:

“Today, Ukraine is applying to make it de jure… We are taking our decisive step by signing Ukraine’s application for accelerated accession to NATO.”

With the four territories now “forever ours” – as the Russian president had put it pointedly in his speech, he seems ready to negotiate a winding down of the conflict, calling on Kiev to lay down its arms. But Zelensky’s response to this was quickly issued:

Ukraine offered Russia “to agree on coexistence on equal, honest, dignified, and fair terms,” but this is impossible with “this Russian president.”

“We are ready for a dialogue with Russia, but with another president of Russia.”

Zelensky response: He says Ukraine is de facto part of NATO alliance. “Today, Ukraine is applying to make it de jure… We are taking our decisive step by signing Ukraine’s application for accelerated accession to NATO.” pic.twitter.com/8Bb8G8xnaF

— Christopher Miller (@ChristopherJM) September 30, 2022

According to Ukrainian regional media, “NATO Secretary General Jens Stoltenberg will hold a briefing on Sept. 30 at 7 p.m. [12pm eastern US time] The topic hasn’t been announced.” 

Is Brussels ready to answer in the affirmative? Or will cooler heads prevail and walk back from the brink?

However NATO chooses to respond, the reality remains that NATO has already been at Russia’s doorstep in Ukraine for years at this point, with weapons shipments and military infrastructure continuing. Increasingly, there looks to be no off-ramp as both sides keep doubling down on threats and action.

By Tsvetana Paraskova of OilPrice.com

Producers of the OPEC+ alliance that are discussing the possibility of agreeing next week on an oil production cut have narrowed the range of options to between 500,000 barrels per day (bpd) and 1 million bpd, sources at OPEC+ told Reuters on Friday.

Major OPEC+ producers have already initiated discussions on a potential cut in their collective oil production quota to support the market, which has been dragged down by fears of a recession in recent weeks.

“Maybe during the weekend or Monday it will be more clear. Usually, the consultations conclude just before the meeting date,” one source at OPEC+ told Reuters today.  

OPEC+ meets on Wednesday, October 5, to discuss the market and fundamentals situation as oil prices have fallen below $90 per barrel, a level last seen just before the Russian invasion of Ukraine.

It is “likely” that the group will agree on a cut, a source at OPEC told Reuters.

At the previous meeting, OPEC+ reversed the 100,000-barrels-per-day increase for September and returned the October quota to the levels from August.

While the slight tweak in the group’s collective target was negligible for oil market balances, OPEC+ signaled readiness to intervene in the market at any time. The meeting in early September decided to “Request the Chairman to consider calling for an OPEC and non-OPEC Ministerial Meeting anytime to address market developments, if necessary.”  

Earlier this week, Reuters sources familiar with Russian thinking said that Russia was likely to propose at the next OPEC+ meeting that the group cut 1 million bpd from the group’s collective output.  

Even if the production cut target is lowered, the actual production cut could be much smaller, considering that many OPEC+ members, including Russia, are pumping well below their respective targets.

Nevertheless, a substantial reduction in the collective quota would be a signal to the market that the OPEC+ alliance is closely watching the price movements, although it always says it doesn’t target a specific price of oil.