Support from the Swiss National Bank, which offered as much as 50 billion francs ($54 billion) from its liquidity facility, had brought some temporary relief to Credit Suisse and risk gauges for the broader European banking sector. That fizzled amid comments from the European Central Bank that some of the region’s lenders could be vulnerable to monetary policy tightening, followed by its decision to proceed with a planned half-point increase in interest rates.

The continued selloff signals more action may be needed to arrest a collapse in confidence that’s prompted clients to step back from the Swiss lender and banks to shield their finances from the potential fallout. While the panic surrounding Credit Suisse has so far shown little sign of infecting the broader financial system, any further turmoil would pose a significant risk for markets already on edge amid soaring interest rates and rampant inflation.

I have always been intrigued by the idea of Aleph null. It’s the infinity of infinities [ℵ0]. The set of natural number is infinite, but so is the set of even numbers, and so is the set of uneven numbers. There is also an infinite number of times a single number can be divided. Most of the time that is an academic novelty but when it comes to confidence and bailouts infinity matters. 

Fears that anything but a half-point hike would trigger panic among investors helped settle the European Central Bank’s interest-rate decision on Thursday, according to people familiar with the talks.

As officials met over the past two days, traders were scouring financial markets for signs that other lenders might suffer the same strains that had hammered Credit Suisse Group AG and Silicon Valley Bank. ECB Vice President Luis de Guindos already warned European finance ministers earlier in the week that banks could be vulnerable to rising borrowing costs.

While the ECB dropped language in their Thursday statement on the future path for rates, there remains a live discussion on the need for more increases to bring inflation under control once market turmoil subsides, said the people who declined to be identified because such deliberations are confidential.

Several hawkish officials still see the terminal rate well above the current 3%, the people said, pointing to President Christine Lagarde’s remark that the ECB “would have more ground to cover” if its baseline outlook for the economy were to be confirmed. Yet, some are questioning whether the peak in borrowing costs might now be lower than previously thought. 

The beginning of a hiking cycle leads to central banks trying to re-establish credibility they will do what is necessary to combat inflation. That also implies they will accept whatever pain in the economy is necessary to achieve that goal. The end of a hiking cycle forces them to reverse course because the economic pain grows so intense that it overwhelms the desire to appear credible. 

Defence budget and levelling up
Mr Hunt confirmed the government will add £11 billion to the defence budget over the next five years and another £30 million is being allocated for veterans.

There will be 12 new investment zones, and they will potentially be in the West Midlands, Greater Manchester, the North East, South Yorkshire, West Yorkshire, East Midlands, Teesside and Liverpool. There will also be at least one in each of Scotland, Wales and Northern Ireland.

Mr Hunt also announced a series of levelling-up and local transport-related funding pots.

Taxes
The chancellor confirmed the planned increase in corporation tax to 25 per cent will be going ahead, but announced a new policy of “full capital expensing” over the next three years, which will mean every pound invested in IT equipment, plant, or machinery can be deducted immediately from profits.

Mr Hunt said he will introduce a new tax credit for small and medium-sized firms that spend 40 per cent of their expenditure on research and development. Tax reliefs for film, TV and video gaming will also be extended, he said.

Up to £20 billion will be allocated for the early development of carbon capture and storage.

Mr Hunt said that, subject to consultation, nuclear power will qualify for the same investment incentives as renewable energy and alongside that “will come more public investment”.

Falling Gilt yields could not come at a better times for the UK and its mortgage holders. The upgraded growth estimate which expects to avoid a recession this year helps to highlight the efforts of the Bank of England to talk the market down were more about affecting sentiment than actually containing growth. 

Charles Schwab Corp. tumbled the most ever on an intraday-basis as the online brokerage sought to reassure investors that it has sufficient liquidity to handle any volatility following the collapse of Silicon Valley Bank.

Shares of Westlake, Texas-based Schwab dropped as much as 23% to $45 after trading was halted for volatility. The stock later pared its decline and was down 17% to $48.93 at 10:09 a.m.
in New York.

The firm has a broad base of customers and capital in excess of regulatory requirements, founder and Co-Chairman Charles Schwab and Chief Executive Officer Walt Bettinger said in a statement on its website Monday.

“Schwab’s long-standing reputation as a safe port in a storm remains intact, driven by record-setting business performance, a conservative balance sheet, a strong liquidity position, and a diversified base of 34 million-plus account-holders who invest with Schwab every day,” the executives wrote.

The company, with roughly $7.4 trillion of client assets, said it has access to about $100 billion of cash flow, more than $300 billion of incremental capacity with the Federal Home Loan Bank and other short-term facilities, and that more than 80% of deposits at its bank are insured by the Federal Deposit
Insurance Corp.
 

Companies like Schwab offered an attractive service to their customers during the big bull market. Instead of selling highly appreciated assets and absorbing the capital gains tax hit, why not offer the stock portfolio as collateral against a loan to buy a new house, car or boat? Real Estate agents I know report that was a major source of funding during the pandemic housing boom. 

80% of the leveraged finance market does not have a maturity until 2026 or beyond, so they have a lot of runway, a lot of liquidity, you got a well telegraphed recession as you talked about, they are cutting expenses and conserving cash. They are well set up to buy themselves time to see how this market unfolds…you just don’t have that crunch. We are coming off the greatest financing wave in history and so maturity has been pushed out and this plays out in that 80% stat I referenced. 

This is one of the most important topics in the debt markets today. Higher rates are obviously troubling for the holders of debt but you don’t get system problems until the borrowers have to pay to refinance and struggle. 

An office landlord controlled by Pacific Investment Management Co. has defaulted on about $1.7 billion of mortgage notes on seven buildings, a sign of widening pain for the industry as property values fall and rising interest rates squeeze borrowers.

The buildings — in San Francisco, New York, Boston and Jersey City, New Jersey — are owned by Columbia Property Trust, which was acquired in 2021 for $3.9 billion by funds managed by Pimco. The mortgages have floating-rate debt, which led to rising monthly payments as interest rates soared last year.

“We, like most office owners, are addressing the unique and unprecedented challenges currently facing our asset class and customer base,” Justina Lombardo, a spokesperson for Columbia Property Trust, said in an emailed statement. “We have engaged with our lenders on a restructuring of our loan on seven properties within our larger national portfolio.  We look forward to a collaborative process yielding thoughtful solutions that reflect current market conditions and best serve the interests of all stakeholders.”

Over the last few months I have been struck by the number of conversations I’d had where investors have been investing in private credit for years already. One way of thinking about it is investment banks are going back to their roots. 

The British premier had been preparing to unveil a new deal this week, but vocal opposition from unionists in Northern Ireland and Brexit hardliners in Sunak’s own Conservative Party scuppered the plan. Sunak had a positive talk with European Commission President Ursula von der Leyen late Friday and they will speak again soon, a person familiar said. He’s also gearing up to talk to his Cabinet before Monday, people directly involved in the plans said.

Sunak also wants to have further discussions with DUP Leader Jeffrey Donaldson, whose party has blocked the formation of Northern Ireland’s devolved power-sharing government for more than a year over the current post-Brexit trading arrangements, known as the Northern Ireland Protocol. His endorsement is likely to prove crucial and without it an announcement of the deal may be further delayed. 

There are three potential solutions to the question of how the Good Friday Agreement fits into the overall Brexit question. The first is the border with the EU is in the middle of the Irish Sea. This is the current situation which Boris Johnson implemented. 

I was watching your commentary today, you seem once again to be somewhat circumspect with regards to longer term bonds the world over, and as you have repeatedly said over recent weeks, yields are in a consistent trend higher. Why then do you continue to hold TLT, a very long duration bond that gets harder hit when yields rise, and the DoubleLine fund too? Can you explain your thinking on this front, as your commentary seems at odds with your actions, in this instance at least.

Thank you for this question which I’m sure will be of interest to the Collective. The simple answer is that bond yields are still trending higher but I do not expect that condition to last. I initiated my long positions at yields I found attractive. I’ll buy more if yields go much higher from here. 

The concern is that inflation doesn’t tick down as quickly as the BOE anticipates. Prices increased 11.1% in October, the most in 41 years. That eased in each of the past three months, but the latest inflation reading at 10.1% remains five times the BOE’s target rate.

The BOE will be heartened by news that inflation in the services sector eased in January. It’s one of the key indicators being watched by policymakers, who see it as gauge of domestically generated inflation that is hard to shift once it takes hold.

The other red flag is wage growth, which is now running at the fastest pace on record outside of the pandemic as labor shortages hand workers unprecedented bargaining power. 

The BOE fears inflation could become entrenched as companies keep raising prices to cover their salary costs. There were some signs of hope in the latest data, however, with figures for December alone showing a slowdown in private-sector pay increases.

The bond market is signaling it is a little early to declare victory over inflation. Gilts yields continues to steady from the region of the 200-day MA and a sustained move below 3% would be required to question potential for continued upside. 

Where next? The best comment, as it also applies to us, comes from one of our managers, Terry Smith: “Our companies should demonstrate a relatively resilient fundamental performance in such circumstances, and the only type of market which ends in a recession is a bear market.”

We are reminded by another market veteran we’ve followed for 40 years, Ed Yardeni, that the FAANGS, the mega tech US stocks which led the 2014 to 2021 bull market, still inflate the PER market rating. Without the FAANGS, the forward market multiple is only 16.7x, making it barely 2 points higher than the long-term average. Bearish commentators claim that earnings are about to take a hit, raising the PER, and rate rises are still in store. (Remember that 2 main factors influence share prices: the valuation of earnings, influenced largely by interest rates, and the earnings themselves). There may indeed be something to the bears’ claim.

Here is a link to the full report. 

Some of the biggest movers in the US market since the beginning of January have been the eight mega-cap household names stocks. Tesla and Nvidia rebounded impressively while Alphabet has been a clear laggard and all largely because of enthusiasm about the promise of AI. 

Brookfield Asset Management Ltd.’s earnings rose in the fourth quarter as it wrapped up a record year of fundraising that has given the firm more than $90 billion to invest. 

The Canadian alternative asset manager reported distributable earnings of $569 million, or 35 cents a share, up 6% from the prior year. It’s the first quarterly report for Brookfield Asset as a public company after it was spun out of parent Brookfield Corp. in December. 

The company raised a record $93 billion in capital last year. “Our fundraising outlook remains strong,” Chief Executive Officer Bruce Flatt and President Connor Teskey said in a letter to shareholders. “In 2023, we expect to have three flagship funds in the market, along with several complementary perpetual strategies and other long-term funds.”

Brookfield Corp. spun off a 25% stake in the division in an effort to gain a higher valuation by separating the money-management business from its own investment capital. Brookfield Asset managed $418 billion in fee-bearing capital at the end of December across asset classes including real estate, infrastructure, credit, private equity and renewable power.  

The Toronto-based company plans to more than double that to $1 trillion by 2027, driven by ambitious plans to grow in private credit and insurance. Some of the growth may come through acquisitions, Flatt suggested at a conference in December.  

$93 billion raised during a bear market for stocks and amid rising yields is an impressive feat. Blackstone is also chasing the moniker of the first alternative asset manager to reach $1 trillion under management. 

Powell says the labor market report from Friday “underscores the message” he sent last week, that there’s a significant road ahead to get inflation down. There’s an expectation that inflation can come down painlessly, but “that’s not the base case.”

The primary conclusion investors have taken from Jerome Powell’s interview today is pain might be coming but rates will quickly adjust when it does. The volatility on the Nasdaq-100 showed the development of this conclusion with a 1% advance, drop back to flat and recovery to finish up 1%. 

A broad gauge of dollar strength jumped after the jobless rate in the US hit a 53-year low as traders amped up bets on a higher policy rate.

The Bloomberg Dollar Spot Index extended gains for its biggest two-day climb in four months after data highlighted the resilience of the labor market and another report showed resurgence in consumer demand, suggesting even more tightening may be in store from the Federal Reserve. 

The greenback gained as much as 1.2%, climbing against all of its peers in the Group of 10, with the Japanese yen, the Australian dollar and New Zealand dollar falling the most. 

“The headline number for nonfarms was shocking, and the US dollar is clearly reacting to that,” said Bipan Rai, a currency strategist at Canadian Imperial Bank of Commerce. “We still have plenty of data to comb through before the picture is complete.”

The simple logic is you cannot have a recession without unemployment rising. That suggests the Federal Reserve is under no pressure to cut rates and may even continue to raise them. That lent considerable support to the Dollar Index and it is working on a large upside weekly key reversal which marks a lot of at least near-term significance. 

The inflation that we originally got was very much a collision between very strong demand and hard supply constraints, not something that you really have seen in prior, you know, in business cycles.

And

I think it's -- because this is not like the other business cycles in so many ways. It may well be that as -- that it will take more slowing than we expect, than I expect to get inflation down to 2 percent.

And

this is not a standard business cycle where you can look at the last 10 times there was a global pandemic and we shut the economy down, and Congress did what it did and we did what we did.

There is some logic to that statement. We have never shut down the entire global economy or printed so much money in such a short period of time. The clear conclusion Powell is taking in predicting a soft landing is that inflation really is transitory. 

The European Central Bank lifted interest rates by a half-point, with President Christine Lagarde saying another such move is almost certain next month, despite conceding that the inflation outlook is improving.

Policymakers, as expected, raised the deposit rate to 2.5%, the highest since 2008. Lagarde warned that the most aggressive bout of monetary tightening in ECB history isn’t done — even as energy prices plunge and the Federal Reserve moderates the pace of its own hikes.

In a statement, the Governing Council said it “intends” to raise rates by another 50 basis points at its March meeting, then “evaluate the subsequent path of its monetary policy.”

The ECB may hike again at the next meeting but clear implication is the peak of the hiking cycle will be lower than the USA’s. The same is true for the Bank of England. The vast sums spent to avoid an energy crisis mean governments will be under pressure to contain costs in future. That will siphon money from speculative activities and help to contain demand driven inflationary pressures. 

Table 1 contains historical return data for the S&P 500 in the first five days of January as well as annual returns. This is the “Early Warning System.” The last 46 times that the first five days had positive returns, the full-year return was positive 38 times, for an 82.6% accuracy ratio. The average S&P 500 gain was 14.3% in those years.

The second part is the S&P 500 return in January and the accuracy in forecasting the return for the year. In years when the S&P 500 had positive returns in the month of January, the average return for the year was 17.6%. The indicator has registered 10 major errors since 1950, for an 85.7% accuracy ratio.

74% of time, the stock market finishes up on the year in nominal terms. The big question for investors is whether the strong positive return for just about every asset in January will improve those odds. At least the market is starting from a lower level so the odds of achieving that goal has been improved. 

There has been no suggestion that the Adani entities would struggle to make these payments, and Adani has flagged interest coverage ratios that show it has the wherewithal to meet such obligations.

But Hindenburg’s report last week alleging “accounting fraud” along with its short position in Adani’s US-traded bonds and non-Indian-traded derivatives has put the debt in the spotlight. Some of the notes have fallen to distressed levels below 70 cents on the dollar that generally show mounting concern about creditworthiness. The securities extended declines Monday after a rebuttal by the Indian conglomerate and as Hindenburg followed with its own response.

Tightening global liquidity causes liquidity issues. We’ve seen several examples of that in the last 12 months. The UK pension crisis, South Korean perpetuals, frontier country sovereign defaults, REIT withdrawal issues are all symptoms of that theme. The issues currently being explored with Adani are part of the same trend. The longer rates stay high and as liquidity tightens the more these issues will appear. Eventually we will see solvency issues arise.

In a recent article, Joseph Stiglitz argues that the current inflation is primarily due to the supply-side shock of the Covid crisis and to shifts in the demand patterns. His view is that the rate of inflation has already peaked - it is 1% higher now than in June 2022. He claims that the rise in interest rates has been largely passed on to consumers via higher prices and that any future interest rate rises would be inflationary.

Thank you for this email which may be of interest. I believe the article you referring to is Stiglitz’s one in Project Syndicate. Here is a section:

Worse, it is not even clear that there is any upside to this approach. In fact, raising interest rates could do more harm than good, by making it more expensive for firms to invest in solutions to the current supply constraints. The US Federal Reserve’s monetary-policy tightening has already curtailed housing construction, even though more supply is precisely what is needed to bring down one of the biggest sources of inflation: housing costs.

Moreover, many price-setters in the housing market may now pass the higher costs of doing business on to renters. And in retail and other markets more broadly, higher interest rates can actually induce price increases as the higher interest rates induce businesses to write down the future value of lost customers relative to the benefits today of higher prices.

To be sure, a deep recession would tame inflation. But why would we invite that? Fed Chair Jerome Powell and his colleagues seem to relish cheering against the economy. Meanwhile, their friends in commercial banking are making out like bandits now that the Fed is paying 4.4% interest on more than $3 trillion of bank reserve balances – yielding a tidy return of more than $130 billion per year.

The assumption the passthrough mechanism from costs to rents is seamless is a big leap. Without a healthy economy that delivers wage growth, rental yields increase through lower purchase prices. This article describing how robo-purchases by institutional investors in property have gone wrong, particularly Opendoor, may also be of interest. 

But in a Nov. 30 speech at the Hutchins Center on Fiscal and Monetary Policy at the Brookings Institution, Powell said he was watching something even more specific -- not core PCE, but core services PCE less housing. "[This] may be the most important category for understanding the future evolution of core inflation," Powell said at the time.

That isn't just specific, it is super specific. Core PCE already strips out food and energy. Core services PCE strips out food, energy, and the cost of physical goods. Powell wants to remove housing as well because "as long as new lease inflation keeps falling, we would expect housing services inflation to begin falling sometime next year," he explained.

When Powell refers to core services PCE less housing, he is really talking about the job market. "Because wages make up the largest cost in delivering these services, the labor market holds the key to understanding inflation in this category," he said. "Thus, another condition we are looking for is the restoration of balance between supply and demand in the labor market."

The Core services ex-housing PCE inflation measure continues to hold above 4% which is higher than at any time since 1992. It does look like it has peaked so the question is how quickly it will contract. The hopes for a soft landing reside in this measure falling back to below 3% and staying there without an uptick in unemployment.  

“In terms of just the macro and company performance, I think it will be much more muted as people capture the inflationary pressures,” he said. “Private equity M&A activity I think will be dampened.”

Concerns around portfolio company performance were not the only challenges up for discussion in the south of France, with private equity firms struggling to secure the debt financing they need to do big deals and juice returns and facing more competition when raising funds. 

The chief economist at German insurer Allianz SE, Ludovic Subran, said the industry had “nowhere to hide” when markets turned last year. “The private equity world has not been immune or has not defied gravity,” he said.

Banks pulling back from lending on buyouts was described as a “new reality” by Francois Jerphagnon, head of Ardian Expansion, in an interview with Bloomberg TV. This will open up an opportunity for private credit funds to step in, others said.

“There is much more interest in private credit and infrastructure where you do have that hedge against inflation and that hedge against rising rates,” said Richards at Pantheon.

Blackstone’s Eapen said private credit providers are in “the middle of a golden age” and that last year had been one of his business’s biggest ever for deploying capital. 

After the credit crisis, the vindictive wish of anyone who lost money in the crash was for banks to go broke. At the very least everyone concluded they needed to be heavily regulated. Today the burden of regulation is heavy within the banking sector and we are in our 15th year since the crash. 

Many junk-rated companies will require urgent funding. They may struggle to find it at a time when investors’ demand for sky-high premiums has effectively shut public capital markets as a refinancing avenue for the most stressed firms.

While default rates are expected to increase, it may not immediately become a flood of failures. A large chunk of high-yielding debt has weak investor safeguards — loose covenants that mean highly indebted firms will be able to delay engaging with creditors until further down the line. 

Moody’s forecasts the global default rate for high-yield companies will increase to 4.9% by November, up from 2.9% a year earlier. In a “severely pessimistic scenario,” however, the rate could go up to 12.6%, it said in a report published last month. 

It stands to reason that when the artificial support for failing companies is removed, they will go bust. Interest rates have surged over the last 12 months, the availability of credit is drying up as banks withdraw from lending and money supply growth is close to contraction on a year over year basis. That suggests many highly leveraged companies will have issues refinancing. 

“The private equity model works,” he said in a Bloomberg TV interview at the World Economic Forum in Davos on Wednesday. “It puts capital to work with experts that really help drive these companies.”

Pagliuca said private equity has “absolutely not” peaked and will still be able to deliver the standard 18% to 20% rate of return in the coming decades. 

“We’ve maintained those returns now every decade for 40 years,” he said. “It’s a great business model.”
Buyout firms are readjusting to an environment of higher interest rates that’s making it harder to finance deals and juice returns by loading companies with cheap debt. Valuations have tumbled in both the public and private markets.

Rising rates are bringing a reckoning for those firms that invested heavily in speculative technology companies at super-high multiples, according to Pagliuca. Bain has largely steered clear of this market and its portfolio is doing “pretty well,” he said.

There is no doubt that a version of the private equity business model continues perform. The investment practices of the world’s largest sovereign wealth funds, where the holding periods stretch from years to decades is a case in point. They have the financial resources to buy in times of market stress and hold for the long term. There will never be a time when buying low and securing growing cashflows with an infinite holding period will fail. 

As part of its deal with the IMF, Egypt agreed to shrink the footprint of all state-run enterprises, including “military-owned companies,” and committed to allow for a more flexible exchange rate.

“We are also looking at our region, and we want to be a role model for the region,” Al-Jadaan said. “We are encouraging a lot of the countries around us to really do reforms,” he said.

 

The UAE’s reluctance to offer donations but attach support to investments is a model Saudi Arabia is now also following. The big oil exporters want regional stability. This change of policy suggests they now appear to believe that will best be achieved through economic reforms.

The Arab Spring shook up the Middle East more than a decade ago and resulted in significant turmoil. It now appears that the policy suite developed in response to those events has matured. Large young populations need to be offered a route to a productive life or rebellion is inevitable. 

The Bank of Japan’s decision to keep its settings unchanged Wednesday gave global investors a modest jolt, leaving markets from the yen to Treasuries at risk from a potentially larger shock if officials opt to shift policy in the future.

Standing pat caught some traders by surprise, but it’s unlikely to douse speculation that the BOJ will normalize policy as inflation in Japan accelerates and Governor Haruhiko Kuroda nears the end of his term. It suggests just a temporary setback to bets on a stronger yen and a bond selloff as analysts say it’s still a question of when — not if — the central bank exits its yield-curve control policy.

Indeed, while Japan’s currency at one stage slumped more than 2% against the dollar in the wake of the decision, it clawed back some ground as the session proceeded, helped by a swath of US economic data that dented the greenback. Japanese government bonds surged as traders covered short positions and stocks pushed higher. US Treasury yields declined.

There were fireworks in Japanese markets this morning as the BoJ demurred from the tampering with its yield curve control policy. However the rebound in bonds and weakness in the Yen were short lived. Traders don’t see yield curve control lasting beyond Kuroda’s tenure. 

Thanks for the interesting comments about Saudi - I spent a couple of years working in Riyadh in the late eighties.

On a different subject do you see the re-occurrence of the US debt ceiling with the Senate's inability to pass (anything...) creating any problems?

Thank you for this topical question which I’m sure will be of interest to other subscribers. On another note, I suspect even veterans of living in Saudi would be surprised at the extent of progress made since MBS has taken power. 

The Tea Party movement gained traction in the aftermath of the credit crisis. They eventually gained enough sway over the Republican Party to force fiscal constraints onto the 2nd Obama administration. The Freedom caucus has given us a sneak peak at the trajectory of budget negotiations in the concessions they squeezed out of Keven McCarthy. 

“I suspect tumult” for markets in 2023, Summers told Bloomberg Television’s “Wall Street Week” with David Westin. “This is going to be remembered as a ‘V’ year when we recognized that we were headed into a different kind of financial era, with different kinds of interest-rate patterns.” 

In every other instance where quantitative tightening has been attempted bonds yields go up first. That is fuelled by fears central bank selling of bonds will crowd out other investors which pushes down prices. That process lasts for several months, then yields come back down. The collapse in yields is driven by rising deflationary fears as liquidity is drained out of the economy.

A link to the full report is posted in the Subscriber's Area. 

The topic of geopolitics and the world order is endlessly surprising because it does not submit readily to a formulaic approach. In fact, it is just when one thinks the future is most visible, that events transpire to muddy the outlook.

Debt markets are increasingly sorting US leveraged loans into two categories: money good, and distressed. 

A growing proportion of prices in the market are either very high, or very low. About 5% of the market is trading under 80 cents on the dollar, a share that has more than doubled since June, according to a JPMorgan Chase & Co. analysis. And more than half the market is trading above 96 cents on the dollar, an amount that has also more than doubled.  

With more loan prices reaching extremes, companies that run into any sort of difficulty can see their loans plunge quickly. That can translate to surging borrowing costs, boosting the chance of corporations defaulting. 

“This puts the worst companies at risk, as they’ll have a harder time refinancing,” said Roberta Goss, senior managing director and head of the bank loan and collateralized loan obligations platform at Pretium Partners LLC, in an interview.  

I used to live around the corner from “Nakatomi Plaza” and always got a kick out of driving past the setting for the Die Hard movie. This property is a prime example of the issues facing many commercial properties. Occupancy rates are spotty. Regions depending on the tech sector are most at risk of high vacancy rates. That is going to put pressure on owners are they refinance loans in a tight liquidity and high interest rate environment.

Good morning, Eoin I would welcome your perspective if I may. I have been long only forever, 40 years and counting. In view of the current global challenges, I am thinking of taking the remaining 60% (40% currently in cash or cash equivalents) off the table and holding all in cash for the time being. I would welcome any observations you may have. I look forward to hearing from you.

Thank you for this important question which may be of interest to the Collective. The biggest argument for remaining long forever is the market always comes back…eventually. Being an investor requires an optimistic mindset. That means there is always a risk of selling too late. There is also the risk that the sectors which lead a recovery are not those you currently own.

The yen whipsawed in Monday trade after reports on a potential change to a key agreement between the government and central bank fueled speculation policy makers are moving closer to a hawkish pivot. 

Japan’s currency jumped as much as 0.6% after Kyodo said on Saturday that Prime Minister Fumio Kishida may seek to revise a decade-old accord with the Bank of Japan and consider adding flexibility to the 2% inflation goal, potentially paving the way for an end to its ultra-dovish policy. The yen pared gains after a top government spokesman denied the report.

The existing agreement commits the government and the BOJ to achieving its 2% inflation goal as early as possible. 

The BOJ has long since missed Kuroda’s original timeline of around two years. Still, removal of the phrase would go a step further in recognizing that achieving stable inflation is a longer term goal while implying that factors other than time also need to be considered.

Japan has been trying to achieve its inflation target for a lot longer than two years. The challenge in the past was the global economy was going through a long-term disinflationary trend at the same time Japan was going through a deflating property bubble. Attempting to inflate while companies were moving jobs and manufacturing capacity offshore was a challenge. Today, the aging population and depressed consumer demand are headwinds to inflation.

As I’ve written many times about the economy and markets, we never know where we’re going, but we ought to know where we are. The bottom line for me is that, in many ways, conditions at this moment are overwhelmingly different from – and mostly less favorable than – those of the post-GFC climate as described above. These changes may be long-lasting, or they may wear off over time. But in my view, we’re unlikely to quickly see the same optimism and ease that marked the post-GFC period.

We’ve gone from the low-return of 2009-21 to a full-return world, and it may become more so in the near term. Investors can now potentially get solid returns from credit instruments, meaning they no longer have to rely as heavily on riskier investments to achieve their overall return targets. Lenders and bargain hunters face much better prospects in this changed environment than they did in 2009-21. And importantly, if you grant that the environment is and may continue to be very different from what it was over the last 13 years – and most of the last 40 years – it should follow that the investment strategies that worked best over those periods may not be the ones that outperform in the years ahead.

That’s the sea change I’m talking about.

There is really only one big question. Will the Fed relent and revert to the GFC playbook when unemployment rises and economic hardship stokes deflationary fears? 2023 will probably deliver an answer.

The product is known as a “collateralised fund obligation” and its aim is to diversify risk by parceling up the companies’ providing returns. CFOs are, in some ways, a private equity variant of “collateralised debt obligations”, the bundles of mortgage-backed securities that only reached the public consciousness when they wreaked havoc during the 2008 financial crisis.

So far, CFOs have flown largely under the radar. Although some of private equity’s largest names such as Blackstone, KKR, Ares and the specialist firm Coller Capital have set up versions, this is often done privately with little or no public disclosure of the vehicle’s contents — or even, in some cases, of its existence, making it all but impossible to build a full picture of who is exposed and on what scale. CFOs introduce a new layer of leverage into a private capital industry already built on debt. Their rise is one illustration of how post-crisis regulation, rather than ending the use of esoteric structures and risky leverage, has shifted it into a quieter, more lightly regulated corner of the financial world.

In the world of investment banking everything can be made better with leverage. Private equity offered rich rewards in the decades before zero interest rates. Then the volume of cash available to the sector ballooned and valuations for the assets they acquired rose in tandem. Leverage is the easy answer for how to sustain returns despite high valuations, which would normally compress yields.

Morgan Stanley projects that a multi-asset income fund can now find some of the best investing opportunities in nearly two decades in dollar-denominated securities, including inflation-linked debt and high-grade corporate obligations. The interest payments on regular 10-year Treasuries, for example, has hit 4.125%, the highest since the global financial crisis.

Meanwhile Pacific Investment Management Co. reckons long-dated securities, the biggest losers in this era of Federal Reserve hawkishness, will bounce back as a recession ignites the bond-safety trade, with government debt acting as a reliable hedge in the 60/40 portfolio complex once more.

“People are excited, believe it or not,” said Maribel Larios, founder and CEO of Fiduciary Experts, a Murrieta, California-based registered investment advisor. “It’s all relative, as they’ve seen these fixed-income accounts pay little to nothing in the past. So, 4% — or even about 2% to 3% in some cash accounts — is relatively good now.”

Banks like Deutsche and Morgan Stanley are taking an axe to their earnings estimates for the S&P500 next year. Corporate earnings have been resilient, even as the Fed has hiked rates faster than at any time in the last 40 years. That is unlikely to persist as the lagged effects of tightening catch up.

Professional investors are loading up on bets that an economic recession can be avoided despite all the warnings to the contrary. It’s a dangerous bet -- for a variety of reasons.

Money managers have been favoring economically sensitive equities, such as industrial companies and commodity producers, according to a study from Goldman Sachs Group Inc. on positioning by mutual funds and hedge funds with assets totaling almost $5 trillion. Shares that tend to do well during economic downturns, like utilities and consumer staples, are currently out of favor, the analysis shows.

The positions amount to wagers that the Federal Reserve can tame inflation without creating a recession, a difficult-to-achieve scenario often referred to as an economic soft landing. The precariousness of such bets was on display Friday and Monday, when strong readings on the labor market and American services sectors drove speculation the Fed will have to maintain its aggressive policies, increasing the risks of a policy error.

“Current sector tilts are consistent with positioning for a soft landing,” Goldman strategists including David Kostin wrote in a note Friday, adding that the fund industry’s thematic and factor exposures point to a similar stance. 

I am reminded of 2007 and 2008 when commodities were surging and banks beginning to roll over. At the time commodity inflation was running rampant but there was relatively little upward pressure on wages. The growing weakness in the housing sector effectively kept wage demand growth under control. Nevertheless, the spike in energy prices and overleverage in the financial system caused a significant problem.

“There will be geographic expansion as these markets continue to evolve along a similar trajectory with a lot of the same trends we saw in the US,” Michael Arougheti, chief executive officer of Ares Management, said of private credit in an interview on Bloomberg Television. “If we continue to demonstrate durable performance through cycles then the appetite for the asset class will continue to grow significantly.”

Yet it is not without risk. With the US economy slowing, more companies that private credit funds lend to may begin defaulting on their repayments next year as earnings decline and interest on their floating-rate loans rises.

“Private credit is a place people can go to benefit from rising rates,” Arougheti said. “The flipside of that is that as rates are going up, debt service becomes more challenging.”

An additional problem is the less stringent valuation process for private credit portfolios compared with assets in public markets, which can leave poor investments hidden for longer.

Private credit ballooned in size following the credit crisis as big banks retreated from riskier parts of the lending market and quantitative easing flooded the market with liquidity. Non-bank lenders now dominate the US mortgage markets. Companies like Citadel dominate market making in stocks. Private equity groups are now some of the largest property owners in the world. Private credit groups are now also dominating commercial credit markets. The fact they are migrating to international markets suggests the domestic US market is at capacity.

In Australia, where the pace of housing declines has eased, the outlook for mortgagees is similarly tough: borrowing capacity has fallen and monthly repayments have surged. In addition, a large chunk of loans that were fixed at record-low rates during the pandemic are due to roll over in 2023 at a much higher rate. 

With the full impact of past hikes yet to be felt, rates still rising and the economy set to weaken, there’s likely still some way to go before prices bottom, said Shane Oliver, chief economist at AMP Capital Markets in Sydney. 

Given expectations that rates will rise higher in both countries, some economists see home values dropping more than 20% from their peaks. 

Rolling fixes is likely to be a major topic of conversation in Australia, Canada, and the UK in 2023. The impending step higher in mortgage payments for millions of consumers is the central dilemma for their respective central banks. They need to raise rates to try and tackle inflationary pressures but every hike makes the problem of consumer debt sustainability worse.

The threshold of 2.52 francs is “the ‘hard underwriting’ price for the consortium of 19 banks,” JPMorgan & Co. analysts said in a research note. If Credit Suisse’s shares keep trading above that level until “the last day of rights trading on Dec. 6, 2022, we can assume at that point the capital raise was most likely a success.”

Having a large number of underwriters makes it easier to find buyers and reduces the risk for the investment banks to get stuck holding a large amount of the shares. As part of the lender’s capital raise plans, Saudi National Bank to invest up to 1.5 billion francs in the lender, becoming a top shareholder. 

Credit Suisse Chairman Axel Lehmann, speaking at a conference in London on Thursday, said that the stock would stabilize after the rights issue is completed and that investors should expect volatility until then. The new shares are due to start trading on Dec. 9. 

“I cannot predict where the share price is going,” Lehmann said. Until the end of the capital raise process, “we will have a little bit of volatility, but then I think it will start to somewhat stabilize and bottom out, and then we go from there.”

Credit Suisse’s share price continues to accelerate lower. A catalogue of management errors has seen the share lose close to 90% of its value since 2013. Tightening global liquidity is a proximate cause of stress, but the bank also needs to address many of the internal controls that led to this condition too.

Since returning from the Chart seminar in London I have spoken to several people who work in the Israeli high-tech industry, They all tell me that about 10% of their colleagues have lost their jobs recently. Today you referred to your MIIN index. How can we invest in these countries?

Thank you for this additional insight. The market for big ideas ballooned with the delivery of free money. Suddenly, no idea was too grand, or time to delivery/commercialization too long. That trend was looking tired in 2019, as the Federal Reserve’s quantitative tightening was siphoning liquidity from the global economy.

“The time for moderating the pace of rate increases may come as soon as the December meeting,” Powell said in the text of his speech. “Given our progress in tightening policy, the timing of that moderation is far less significant than the questions of how much further we will need to raise rates to control inflation, and the length of time it will be necessary to hold policy at a restrictive level.”

Policy-sensitive 2-year Treasury yields fell on Powell’s remarks, erasing increases on the day, and the S&P 500 index reversed losses to trade higher. The dollar slipped in value against major rivals on foreign-exchange markets.

The Fed’s actions -- the most aggressive since the 1980s -- have lifted the target range of their benchmark rate to 3.75% to 4% from nearly zero in March. Powell said rates are likely to reach a “somewhat higher” level than officials estimated in September, when the median projection was for 4.6% next year. Those projections will be updated at the December meeting.

Jerome Powell confirmed today that the pace of Fed hikes will moderate; not reverse or pause. Nevertheless, cashed-up traders are more than willing to take anything less than outright hawkishness as good news.

I see a third question more related to the protests, not COVID, and I apologize in advance for the potential false equivalency. When comparing Europe's energy situation and the global supply chain / China sourcing situation how will each unfold in future years? Certainly both are heading directions (reversing) that will not turn. Are Europe's hooks deeper into the Russian supply habit or is the global supply chain China habit even deeper?

I am most interested in the impact similarities these two withdrawal themes may have on the West, and the length of time change will take. I have long thought North America "has it all" when you look at materials, labor, and markets.

Thank you for this question which raises some important points. The conclusion that Europe is in a more difficult position than North America is clear but nothing is ever so simple.

Europe relied on Russia to supply much of its energy and much of the money spent on imports was recycled through European countries. That is over. Europe now needs to mirror the USA’s success in becoming energy-independent.

Global bond yields will likely fall slightly in 2023 as the balance between demand and supply will improve by $1 trillion, strategists at J.P. Morgan said in a note.

There will be a $700 billion contraction in global bond demand next year compared to 2022, while bond supply will likely drop by $1.6 trillion, J.P. Morgan strategists, led by Nikolaos Panigirtzoglou, estimated in the note issued on Thursday.

"Based on the historical relationship between annual changes in excess supply and the Global Aggregate bond index yield, a $1 trillion improvement in the demand/supply balance would imply downward pressure on Global Aggregate yields of around 40 basis points," the Wall Street bank said.

J.P. Morgan said that while major central banks trimming their balance sheets in 2022 was the single largest contributor to deterioration in bond demand, sell-offs by commercial banks and retail investors were also much higher than estimates.

There is a strong likelihood inflationary pressures will fall next year. There are three major reasons for believing that.

By March, it will be a year since the Bank of Canada began raising interest rates — meaning ever more of the record number of people who took out short-term or floating-rate mortgages at historically low rates will find themselves fully exposed to the roughly fourfold jump in borrowing costs since then, a potentially catastrophic shock to their personal finances.

The fate of Canada’s housing market will depend on whether or not they can hold on. And just as the country was a leader in the years-long global real estate frenzy, how its downturn plays out — a relatively orderly correction, or a brutal crash — may be a harbinger for what awaits the rest of the world.

Housing markets around the globe are wobbling under the weight of central bank rate-hike campaigns, with a handful of frothy countries joining Canada in already seeing precipitous price declines. More than a dozen developed economies, from Australia to Sweden to the US, are in the midst of downturns — defined as two consecutive quarters of falling prices — or will be by the beginning of next year, according to Oxford Economics. If those slumps prove worse or more widespread than expected, it would deepen a potential global recession. 

 

The Canadian 10-year yield appears to have reached a near-term peak in the region of 3.5%. The rate is coming back towards the trend mean so this will be a significant region to test whether demand dominance has returned beyond short-term steadying.

On the income side, if you earn more than £100,000, you really should be looking at how to put as much of your salary as you can above that amount into a pension via salary sacrifice. Why’s that? Because contrary to what you might think, you’re not paying a 40% marginal tax rate. As the team at tax advisors Blick Rothenberg point out, your marginal tax rate is in fact closer to 60%, because £100,000 is the point at which your personal allowance starts to get whittled away. (This is also why the 45% rate was cut to £125,140 rather than £125,000 — so that it aligns with the point at which your personal allowance is all gone.)

As a result, any money you can shield from this rate is doing a great deal more work than any other pound you save. That said, given that your mortgage is probably going up, and your heating bill is through the roof, it’s quite possible that you are already doing as much as you can on that front without causing a major liquidity crisis in your household.

On the investment side, falling squarely into the “be thankful for small mercies” category, at least the chancellor didn’t mess around with the annual allowances for tax-efficient “wrappers” — you can still put up to £20,000 a year into an individual savings account, and up to £40,000 a year into a pension (assuming you earn that much each year). The latter of course is still subject to the (frozen) lifetime allowance, so do be careful if you’re in danger of breaching that £1.073 million lifetime cap.  

So if you have grown a bit sloppy with your admin, and you are holding any shares outside a tax wrapper (i.e. an Individual Savings Account or a pension), then now is the time to get a handle on that and move them. At least then you’ll be shielded from dividend or capital gains taxes. If you have already exhausted these allowances, you might want to start looking at venture capital trusts or enterprise investment schemes, though those are a topic for another day. 

Government rules tend to change investor behaviour. The perversion, that is the tax system, means the incentive to make a lot of money from working is actively under attack. Instead one is being encouraged to invest as much as possible to shield assets from the tax regime. That basically means outsourcing the job of making money to companies rather than individuals. That’s not great news for hard workers, but it certainly benefits the asset management sector.

Interested in your investment purchase of DoubleLine Income Solutions Fund. as a long term subscriber I’ve now moved into another investment age whereby I am now an income & growth investor and the timing of your purchase appears to be potentially beneficial.

I have checked with a number of UK online investment portals and they do not appear to offer access to this closed end fund and therefore my question is whether you accessed this via a US trading platform or direct?

Any help will be appreciated.

Thank you for this question which may be of interest to the Collective. Growing up in Ireland in the last 1970s and early 1980s interest rates were very high. My grandmother used to buy national savings certs for all her grandchildren. They automatically rolled over the interest at maturity. As a teenager, I cashed them in and found they had risen by over 300%. That taught me the simple lesson. Buying bonds when rates are high and before inflation peaks is very attractive.

For lower-earning families unaffected by the child benefit clawback, but perhaps struggling even more, it is usually possible to transfer £1,260 of a non-working spouse’s personal income tax allowance to the working partner. This can potentially save £252 a year. Again though, this is not automatic, it must be claimed.

And these are far from the only tax anomalies. Since 2009, those earning more than £100,000 a year have had their personal income tax allowances clawed back at the rate of £1 for every £2 earned above the threshold. Worse still, the threshold has been unchanged for more than 13 years. Anyone earning £125,140 or more loses the entirety of their personal income tax allowance. 

Here again, making additional pension contributions is a good option for reducing your taxable income — and for those earning more than £100,000, it might be a more realistic option. The sweetener is that the effective tax relief for those affected can be up to 60%. For these people, the government effectively contributes £60 for every £40 they pay into their pensions.

Stealth taxes make things more complicated for everyone. Many lower-earners end up paying far more tax than necessary, or not receiving a benefit to which they might otherwise be entitled, often both.

Unfortunately, especially during periods of rapid inflation, such tax strategies are the gift that keeps on giving for governments, raising additional revenue without having to increase tax rates. .

As an old ad for Morgan Stanley once claimed, “You must pay taxes. But there’s no law that says you have to leave a tip.”

I saw this chart from Eurostat yesterday and it surprised me that the European aggregate tax haul had risen so much ahead of the pandemic.

With the overwhelming spending patterns of the pandemic and the resulting inflation, there is clear need to fiscal consolidation. At present that is focusing on tax hikes but the ultimate nettle that needs to be grasped is spending cuts. That’s not just true of the UK, it’s an issue most European countries and the USA have to deal with eventually.

Even though markets gained on Zhao’s tweet, such a fund may not be best for the industry, said Quantum Economics founder and Chief Executive Officer Mati Greenspan. Binance already has too much control in a decentralized market, he said.

“That sort of concentration of power makes me uncomfortable,” said Greenspan. “It’s the kind of thing crypto was designed to avoid and one of the lessons we should have learned from last week.”

Meanwhile, Elon Musk’s tweet that Bitcoin “will make it” also gave crypto markets a boost, said Greenspan. Dogecoin, a token the Tesla CEO has touted in the past, gained as much as 7.9%.

This is yet another example of the paradox of decentralized finance. It’s appealing in theory but the benefits of centralized control become evident during crises. A truly decentralized system does not have a buffer against bank runs. It is looking likely Binance will come through this crisis with a dominant position in the “decentralized” finance market.

Thanks a lot for another very informative Friday video. Could you please kindly comment on the Chinese Construction Companies’ default situation. How serious and general are the defaults of their international bonds. Thanks in advance.

Thank you for this topical question which may be of interest to the Collective. This Reuters article, dated September 2nd, included a table of the biggest bond defaults up to that point in 2022.
 

As the hosts point out, the best time to buy bonds is when yields are high and inflation is peaking. The higher yield offers a margin for error even if it takes time for the macro details to work themselves out.

Treasury bill supply could rise by $1 trillion by the end of 2023, but the impending debt ceiling episode will complicate the timing, according to Bank of America strategists. 

Strategists Mark Cabana and Katie Craig estimate Treasury will issue about $193 billion of bills in 4Q 2022 and $257 billion in 1Q 2023, with particularly strong months of supply in November, February and March because they are typically heavy deficit months that require additional issuance to sustain the cash balance

However, bill supply projections and the associated market impact are complicated by uncertainty around the timing of the debt limit, another round of money-market reform and the Federal Reserve’s quantitative tightening

Positive quarters of bill supply should help cheapen bills relative to overnight index swaps, and strategists estimate spreads should narrow by 10 basis points or more

Still, the monthly path of bill issuance is “much less clear” because of the debt ceiling, which could become constraining as early as December 2022

At that point Treasury would enter a debt issuance suspension period, which would restrict their ability to issue debt -- likely cutting bills to keep coupon sizes unchanged

Strategists project the potential default, or x-date, would be in August or September 2023. After that, there would be a surge of bill supply to replenish the cash balance

The big question for anyone issuing debt is whether there is a sufficiently large pool of willing buyers to support the market. The Bank of Japan has been buying bonds for so long that it has largely crowded out the domestic market. Liquidity in the 10-yeasr is at an all time low. This condition raises important questions for the US government because $1 trillion deficits appear to be the norm.

“This is a devil’s bargain,” said Steve Chiavarone, senior portfolio manager at Federated Hermes. “Size of rate hikes will likely fall, but terminal rate is likely higher -- the implication is a greater number of smaller rate hikes. That is not dovish.” 

Jay Powell said in plain English it is better to overtighten, and cut later, than to under tighten and risk allowing inflation to become entrenched. That’s about as hawkish as it gets. The Fed wants a recession and they will keep going until they kill demand.

Turkey was the biggest buyer of gold during the quarter, followed by Uzbekistan (26.13 tons) and India (17.46 tons). Not all countries report their gold purchases regularly, so it’s difficult to know how much, for example, China and Russia bought during this same period.

India is also shoring up its gold reserves.

Indian consumers habitually purchase gold jewelry ahead of the festive season every October. But that aside, the Reserve Bank of India (RBI) bought 13 tons of gold in July and 4 tons in September, pushing its reserves to 785 tons, according to the WGC.

Any foreign exchange and gold reserves Russia had overseas have been confiscated. That’s a big lesson for every country that is suspicious of NATO’s motives now and in the future. It is therefore reasonable for countries to favour gold over holding foreign currency because at least the gold is a physical entity that can be held internally. Nuclear weapons are now also a must have to defend against invasion for any country that holds opposing views to NATO.

The surprise pickup in vacancies highlights unrelenting demand for workers despite mounting economic headwinds. The persistent imbalance between labor supply and demand continues to underpin robust wage growth, adding to widespread price pressures and reinforcing expectations for yet another large rate hike on Wednesday.

The latest increase in openings erased much of August’s slide, which, at the time, had suggested a notable moderation in labor demand.

“After the shock of last month’s report, the September JOLTS data is returning to a familiar story: demand for workers remains robust,” Nick Bunker, head of economic research at Indeed Hiring Lab, said in a note. “By all the key metrics in this report, the labor market is resilient.”

There is no easy way to address a shortage of workers because someone is going to be upset by whatever solution is suggested. Immigration is the most expedient but it comes with significant political pitfalls and will invariably change the culture of wherever migrants congregate most.

In September, a sharp slide in the yen following the policy statement and dovish comments by Kuroda prompted Finance Minister Shunichi Suzuki to order Japan’s first entry into markets to prop up the currency in 24 years. While the governor moved the market again during Friday’s briefing, his tone was more cautious and his remarks weren’t preceded by falls in the currency like the previous month. 

Kuroda continues to hold firm as the last anchor of low global rates just a day after the European Central Bank went ahead with another jumbo rate hike. But the governor is walking on a tightrope as his stance risks putting further downward pressure on the yen despite billions of dollars spent by the government to support the currency.  

“The likelihood of the BOJ pivoting toward tightening is still small as Japan’s inflation is not broad based at all and is only rising about a third of the pace seen in Europe and US,” said Kyohei Morita, chief Japan economist at Nomura Securities.

The speed of the Yen’s decline since March has alarmed politicians and not least because the price of oil is in the region of the 2008 peak when redenominated into the currency. The Bank of Japan’s challenge is much of the inflation is imported. Domestic demand needs a cultural change and that will not be achieved by transient price pressures.

Inversions of this segment of the Treasury curve typically occur late in Fed tightening cycles as three-month bills track the policy rate while longer-term borrowing costs reflect expectations for economic growth and inflation. While other widely-watched yield curve segments such as the two- to 10-year and five- to 30-year have been deeply inverted for much of this year, the Fed follows this one more closely.

“We are certainly in territory with the Fed’s official barometer of the yield curve that will raise concerns,” said Gregory Faranello, head of US rates trading and strategy at AmeriVet Securities. “The Fed will definitely watch this, and there is a sense in the bond market that they will soon throttle back the pace of rate hikes and take a step back.”

The 10-year – 3-month spread spent part of today inverted following an 11.65 basis-point contraction. The spread was at 223 basis points in May so this tightening has been the fastest in decades. The fact there was such a wide divergence between the 10-year – 2-year and the 10-year – 3-month was regarded as an oddity but reflected the stresses in the bond market.

The US economy does not appear to be on the brink of recession at the moment. In thinking about the odds of a recession next year, we break the risks into three categories: (1) the risk that a recession will prove necessary to bring inflation down, (2) the risk that the Fed will cause a recession that is not necessary, and (3) the risk that something else will cause a recession.

The odds that a recession will prove necessary have fallen a little because the first two steps of the required adjustment—slowing GDP growth to a below-potential pace and rebalancing supply and demand in the labor market— have gone remarkably well so far. But it would be premature to say that this risk has fallen too much until we see consistent evidence that labor market rebalancing is slowing wage growth and breaking the wage-price feedback loop.

The odds that the Fed will cause a recession that is not necessary have likely risen somewhat. It is increasingly clear that shelter and health care inflation— and by extension commonly used measures of the underlying inflation trend such as trimmed-mean inflation—are likely to remain uncomfortably high throughout 2023 and would even if the labor market rebalanced tomorrow. While it is not our base case, we see some risk that too great a focus on lagging indicators, too little patience, or tightening too quickly to gauge the impact on the economy could result in a recession that is not necessary.

A link to the full report is posted in the Subscriber's Area.

I used this slide in my IFTA conference slide deck a year ago. At the time, worry about inflation was not urgent even through the 5-year has broken highs and had first step above the base characteristics.

As I thought about what to talk about at the NAAIM conference today, I thought it would be time to update my chart. In the last year, yields have surged and instead of the illusory dragon, today Jay Powell is being tasked with slaying the inflation dragon.

“Credibility is hard won and easily lost,” Ramsden said. “That credibility is being recovered. That has to be followed through. A return to the kind of stability around policy making and around the framing of fiscal events will be really important.”

He said the issue with the Sept. 23 statement was that “it had one side of the fiscal arithmetic in it” and that the decision to include forecasts from the Office for Budget Responsibility will help underpin the confidence investors have in assessing the UK budget due out next week.

“What we are going to get on Oct. 31 will be very important,” Ramsden said. “My sense is that will take account of all the statements on both the revenue and on the spending side.”

 

The bond market has become relevant in politics again for the first time in decades. Liz Truss was unfortunate to find that out in real time. Donald Trump demonstrated that you could engage in procyclical policies and manufacture a swifter expansion. Now most politicians think they can do the same thing. The problem is he did that before inflation took off. Now, the quantity of debt has multiplied, inflation is problematic and fiscal austerity is back on the menu.

Nochu dominated the CLO market until 2019, when it exited amid regulatory and political scrutiny. The Japanese bank would buy all the top-rated securities in a deal. It returned to the US market in late 2021 and to Europe in recent months, but it was buying far fewer securities. 

But with Nochu backing out again, a critical buyer is gone, potentially slowing down CLO sales, money managers said. And others are buying existing deals in the secondary market.

“In a tight CLO liability market the loss of any buyer makes a difference,” said Dagmara Michalczuk, an investor at Tetragon Financial, in an interview. CLO issuance for the remainder of the year is likely to be more uneven than in the last quarter of 2021, she said.

Big institutional buyers will buy every day as long as they are making money. When a favoured strategy stops working it causes a crisis of confidence. Whole business lines have been developed to thrive from the trade. When it stops making money the best performing sector becomes an internal problem that requires a remedy.

Banks in Switzerland sought the most dollars since 2008 using an emergency dollar swap facility provided by the Federal Reserve in what is likely to be a bid for easy profits.

In Wednesday’s auction conducted by the Swiss National Bank, 17 institutions took up $11.09 billion. That’s the most since October 2008, when the Global Financial Crisis was raging in the wake of Lehman Brothers’ collapse. 

This is the fourth week in a row when banks have accessed the facility. Last Wednesday, 15 banks took up $6.27 billion in funds. 

According to economists at Credit Suisse, Swiss banks swap the dollars into francs in order to generate a profit. The lenders can even sell the cash back to the SNB using its reverse repo auctions, or deposit it at the institution to benefit from a positive interest rate.

“We do not believe that the increased demand for US dollar liquidity by domestic banks reflects any liquidity issues in the Swiss banking system”, Credit Suisse economist Maxime Botteron wrote in a report last week.

The dollar swap facility was created during the crisis that began in 2007 as a lifeline to provide safe access to Greenback liquidity, while the SNB’s cash-taking repo auctions are designed to drain excess liquidity from the market. 

It’s not clear that Swiss officials are likely to act to stop banks from taking advantage of the facility. Conditions of the dollar auctions are controlled by the Fed, and the reverse repos are a core instrument in the SNB’s current tightening of monetary policy.

All Swiss and foreign banks which have a branch in Switzerland or are registered with Swiss authorities are entitled to participate in the dollar auctions. Credit Suisse expects predominantly smaller banks to take advantage of the profit play.

The world is dealing with falling supply of Dollars as rates rise and money supply shrinks. Tapping swap lines to source dollars which can then be sold for a profit is a handy money making exercise for banks. 

A rally in the S&P 500 faded after Philadelphia Fed President Patrick Harker said officials are likely to raise interest rates to “well above” 4% this year and hold them at restrictive levels to combat inflation, while leaving the door open to doing more if needed.

Traders also sifted through a mixed bag of corporate earnings, with Tesla Inc.’s sales disappointing and International Business Machines Corp. surging on a bullish forecast. Several market observers remarked that the bar has been lowered quite a bit ahead of the current earnings season, boosting the odds of upside surprises. It’s also worth pointing out that there’s been no shortage of warning signals about the economy when it comes to corporate outlooks.

Alcoa Corp. -- which is a dependable barometer of US economic health across industries including construction, automotive, aerospace and consumer packaging -- said demand for the world’s heavy industries is falling. Union Pacific Corp., the largest US freight railroad, cut its forecast for volume growth to reflect a “challenging year.”

As traders wade through corporate results, “with an extra eye on guidance, expect volatility to remain elevated,” said Mike Loewengart at Morgan Stanley Global Investment Office

Earnings are holding up but guidance is being lowered. CEOs are at their most bearish in years but investors have cash to burn and are eager to salvage a dire year for their performance. Appetite for buying the dip following upside key day reversals for mega-cap stocks last week is still evident.

We study the impact of remote work on the commercial office sector. We document large shifts in lease revenues, office occupancy, lease renewal rates, lease durations, and market rents as firms shifted to remote work in the wake of the Covid-19 pandemic. We show that the pandemic has had large effects on both current and expected future cash flows for office buildings. Remote work also changes the risk premium on office real estate. We revalue the stock of New York City commercial office buildings taking into account pandemic-induced cash flow and discount rate effects. We find a 45% decline in office values in 2020 and 39% in the longer-run, the latter representing a $453 billion value destruction. Higher quality office buildings were somewhat buffered against these trends due to a flight to quality, while lower quality office buildings see much more dramatic swings. These valuation changes have repercussions for local public finances and financial sector stability.

San Francisco commercial real estate occupancy is below 40% while New York and Los Angeles are just higher than that figure. This is a looming issue for the owners of vacant properties, many of whom are pension funds and other private investors. 

Despite the drop in valuation, the listing is set to be one of the year’s biggest IPOs. Amid heightened volatility and disappointing debut performances of last year’s listings, IPO volume in the US has plummeted to $22.3 billion this year, compared with $277 billion at this point in 2021, according to data compiled by Bloomberg. Instacart Inc., another highly anticipated IPO, last week cut its valuation for the third time, to $13 billion, and is waiting for the markets to settle before going ahead with a listing. Another deterrent for new listings is the fact that many companies that went public in 2020 and 2021 are trading below their IPO prices.

But some analysts said it was reasonable for Intel to go through with the listing despite the poor market timing. Analysts at Bernstein said Intel likely needs the money it will receive from the deal, “given the way their own business is currently trending.” And Vital Knowledge analysts wrote that the “headline is negative, but keep in mind the $50B valuation was floated back in December, so no one should be shocked that the number is now lower today.” Intel shares were up about 1.4% in early trading in New York. 

At present we have straws in the wind but the issues with alternative asset valuations are going to become pressure points for investors over the next couple of years. The LDI debacle in the UK where pensions engaged in financial engineering to avoid leverage rules is the thin end of the wedge.

The reality is QE and the low interest rate environment robbed savers, like pension funds, and forced them to become speculators. At the same time it favoured risk takers and inflated their assets. That allowed both to prosper for a long time but rising rates and tighter liquidity mean the party is over.

Margin calls for more collateral are still coming through, though at a less aggressive pace than two weeks ago, according to market participants, who asked not to be identified. Funds are still selling assets to meet them, managers are trying to lobby the BOE, everyone is bracing for next week when the central bank support has gone, they said. 

Many funds are making tough choices in the run up to the deadline. Almost daily they have been having to decide whether to dump assets to raise cash for possible future margin calls, which would weigh on returns; reduce their LDI positions, which would leave them more exposed if rates turn back around; or find other ways to get some cash.

Some have asked the corporates, whose employees pensions they manage, for emergency short-term loans so they don’t have to sell prized assets. Others have agreed that the companies could accelerate already-agreed payments they would have made to their pension schemes over several years, according to consultants, who asked not to be identified discussing their clients. This means some companies have been stumping up large one-off payments to their pensions, the people said.

“For instance, if they had a pre-agreed payment plan to put in cash on a monthly schedule, some have decided to make an advanced contribution equivalent to one year’s deficit recovery payment,” Norbert Fullerton, a partner at Lane Clark and Peacock said.

“Across the industry there are schemes that can’t raise enough cash and have had to reduce their leverage and hedge ratios,” he said. “It’s an unfortunate situation to be in but some don’t have sufficient liquid assets to sell.”

Every pension fund has been faced with the same challenge. They need an assumed return of 7-8%. When bond yields collapsed and stayed down for a decade, the scope for compounding disappeared. Quantitative easing was often described as favouring traders at the expense of savers and the dilemma faced by pensions is a vivid example of that.

European Central Bank Governing Council member Pierre Wunsch said interest rates may eventually have to top 3% to get record inflation under control. 

“My bet would be it’s going to be over 2%, and I would not be surprised if we have to go to above 3% at some point,” Wunsch told CNBC in an interview in Washington. 

Wunsch also said:

The ECB’s deposit rate, currently 0.75%, will “most probably” need to exceed 2% year-end

“Frankly on the basis of our base case, which is now more or less a technical recession in Europe, I think we are going to have to go real positive somewhere”

“We’ve been claiming that what happens in Europe is different from the U.K., from the U.S. But over the last six months basically the direction we’ve been taking was not that different”

The ECB’s rate peaked at 4.25% in 2008. That suggests the anticipated peak of hiking, at 3%, will be well below that 2008 peak. That’s only relevant because the Fed Funds rate could exceed its 2007 peak at 5.25% before this hiking cycle has ended. That raises the question why is the Euro rebounding?

“Has the government finally heeded the calls from markets and the Bank of England? Price action in gilts and the pound suggests markets believe so,” said Simon Harvey, head of FX analysis at Monex Europe. 

The plan to freeze corporation tax next year has come in for particular attention from detractors within Truss’s own Tories. Under a strategy set out by the previous Conservative administration, the levy on companies was due to rise to 25% from 19% in April. But scrapping that move was one of the key measures in Kwarteng’s fiscal plan announced Sept. 23.

The initial market reaction on Thursday suggests that a U-turn on corporation tax -- along with the bank’s greater buying activity this week -- could help ease any turbulence next week after the Bank of England halts its bond purchases on Friday. Investors will be focused on the details of the plans the government is drawing up, and that may determine whether the broad market rally can be sustained.

“Given investors are short, the reaction of sterling is not a surprise,” said Gareth Gettinby, portfolio manager at Aegon Asset Management. “Ultimately, the UK has an extremely negative external balance that remains reliant on foreign funding which remains a negative. So a short term bounce on government noise and then expect the currency to weaken.”

Confidence in the standard of UK governance has taken a beating recently. The government has few options when the bond market is throwing a fit at the prospect of modern monetary theory gone wild. They will inevitably have to walk back the commitment to lower taxes and will hopefully double down on deregulation.

“Bailey’s words did sound harsh but from the BOE’s perspective they need to sound stern,” said Pooja Kumra, rates strategist at Toronto-Dominion Bank. “The BOE has been very receptive to markets. If chaos continues we doubt that they will run away.”

The Bank of England is in a very difficult position. They desperately need to act against inflationary pressures but are constrained from using the tools at their disposal because of the risk posed by leverage in the financial system, not least in the pension sector.

Russia’s President Vladimir Putin said any energy infrastructure in the world is at risk after the explosions on the Nord Stream gas pipelines.

The attacks were an act of terror that set “the most dangerous precedent,” the Russian president told a Moscow energy forum on Wednesday. “It shows that any critically important object of transport, energy or utilities infrastructure is under threat” irrespective of where it is located or by whom it is managed, he said.

Putin blamed the sabotage on the US, Ukraine and Poland, calling them “beneficiaries” of the blasts that caused major gas leaks in the Baltic Sea. The US and its allies have rejected those allegations and suggest Russia may have been behind the underwater blasts.

The attacks on two strings of Nord Stream and one string of Nord Stream 2 at the end of September have raised concerns over the future of Europe’s gas supplies. Other critical infrastructure in the region has also suffered damage in recent weeks. 

Earlier this month, an act of sabotage halted train services across northern Germany and the government has said it can’t rule out foreign involvement. A pipeline that carries Russian oil through Poland was found to be leaking on Tuesday. Investigations continue, and Poland’s top official in charge of strategic energy infrastructure said he assumed it was an accident.

This is a none too subtle threat to expect escalation of attacks on energy infrastructure for as long as the EU is supporting Ukraine’s resistance efforts. The sabotage of Germany’s rail network with specialized interruptions conducted simultaneously at locations 200km apart is a display of Russia’s extraterritorial ability to sow disruption.

It will be interesting to see whether the higher gilt yields (and turbulent stock markets) lead to an increased demand for fixed pension annuities and thus a new demand for gilts

Thank you for this email which may be of interest. Annuity sales in the USA set a record in the 2nd quarter of this year at $79.4 billion. With so much volatility in stock markets there has been significant demand for guaranteed returns and particularly now since bonds pay a modest yield. 

Should Social Security beneficiaries see an 8.7% increase in their monthly checks next year, it would mark the steepest annual adjustment since 1981, when recipients saw an 11.2% bump. An increase of that magnitude would raise the average retiree benefit of $1,656 by about $144 per month or roughly $1,729 annually, the group said.

"A COLA of 8.7% is extremely rare and would be the highest ever received by most Social Security beneficiaries alive today," Mary Johnson, a policy analyst at the Senior Citizens League who conducted the research, said. "There were only three other times since the start of automatic adjustments that it was higher."

However, the decades-high benefit increase is not always good news for recipients, according to Johnson.

Higher Social Security payments are a bit of a Catch-22. They can reduce eligibility for low-income safety net programs, like food stamps, and can push people into higher tax brackets, meaning retirees will pay more taxes on a bigger share of their monthly payments.

There is a lot of complication in the US tax code but one thing is certain, if you make more you pay more. That both increases compliance costs and ticks people off when they believe they should not have to pay taxes. It’s likely to become a political factor in coming elections.

Thank you so much for a superb and invaluable service. I’ve been a subscriber since the ‘80s. I’ve just recently renewed my subscription again after a short break of a couple of years. Just so enjoying hearing your thoughts and steady guidance through these volatile times, thank you. I’d really enjoy your thoughts re this recent article from Reuters ‘Pension fund blowup faces brutal second act’ which may also be of interest to the collective

Thank you for your kind words and this question which I’m sure others have an interest in. The short answer is the blowup of pension funds in the liability-driven investing (LBI) sector is likely to have a long tail. Pensions are now going to be much more wary about taking on leverage so they are forced sellers of illiquid assets. 

Investors counting on a Federal Reserve pivot any time soon are bound to get burned again, according to PGIM Fixed Income.

“We’ve seen this movie time and time again,” said Greg Peters, co-chief investment officer at the Newark-based firm, in an interview. “The market gets hyped up on different narratives between inflation releases. I’ve been surprised by it, and we’ve been using it as an opportunity to sell into.”

The firm, which manages assets of $790 billion, sold US Treasuries after a rally earlier this week sparked by speculation the Fed was about to turn more dovish. The market move proved short lived, backing its view that there’s still not enough evidence to suggest policy makers will rein in aggressive interest-rate hikes.

The speculation -- fueled by a smaller-than-expected rate hike in Australia -- drove action across global markets in the first two days of this week, driving down two-year Treasury yields by nearly 30 basis points at one point to below 4%.

Neel Kashkari, who has historically been viewed as a dove, was quoted today as saying "more work to do" on bringing down inflation, and is "quite a ways away" from being able to pause its aggressive interest-rate hikes.

Such maneuvers had been a decade in the making. Easy money after the global financial crisis made debt investors hungry to buy loans and bonds that provided higher yields. Funds began to agree to weaker protections in their creditor agreements. Loan and bond documents riddled with loopholes and imprecise language gave borrowers more flexibility in times of stress.

The documents didn’t explicitly allow future creditors to grab collateral. But they left just enough ambiguity, sometimes called “trap doors,” for lawyers with a bit of ingenuity and a lot of motivation to move assets to new entities and give dying companies some fresh capital. Because of these often-overlooked provisions, some creditors were surprised to discover they’d been left with almost worthless loans and bonds after struggling companies restructured.

“Loose documents have become the norm rather than the exception,” says Damian Schaible, co-head of restructuring at Davis Polk & Wardwell. “If we go into a real recession, we are going to see more and more borrowers and sponsors seeking to exploit document loopholes to create leverage against and among their creditors.”

Covenant light debt issuance has dominated the post Global Financial Crisis bond markets. That hasn’t mattered until now. Default rates were low, successive waves of new money ensured rates stayed low, and credit remained abundant. 

Upgrade from Cautious to Attractive: No one knows exactly when this downturn will end and we find it difficult to get ahead of macro events, but we see signals that suggest we should no longer be overly pessimistic: (1) the cyclical sell-off has already been punitive in an historical context; (2) the magnitude of the valuation correction (YoY) is approaching extremes relative to the last two decades; (3) earnings risks are now well understood and it is surprises that will drive stocks from here; (4) green shoots are emerging while some consumer parts of tech are close to bottoming; (5) we are upgrading our top down EM strategy view on IT, Korea, and Taiwan; these are set-up for a reversal in returns in the coming weeks. What is not understood is cycle turns and the market's willingness to increasingly look through this late stage of the downturn and, hence, our focus on the other side of the cycle.

An inflection is near and we see reasons to be constructive on a 2H23 recovery. (1) Macro headwinds are fading with the bulk of the Fed’s heavy lifting likely to be done by year-end and benefits from China’s reopening; (2) demand elasticity and replacement cycles will be driven by the sharp fall in pricing, especially consumer products; and (3) supply adjustment is accelerating via significant production and capex cuts that are underway. We have clearly worked through the slowdown in the consumer and are most positive on 'first-in, first out' exposure in LCD panels bottoming now, followed by memory in 4Q22, while the trough for foundry, auto and semicap should come with a lag in 1H23.

As the fourth quarter begins and investors position for how they hope to salvage returns for 2022, questions are already arising about the prospects for 2023. There is no doubt, steep declines in asset prices, particularly within the tech sector, have improved valuations. In normal circumstances that would be sufficient to create attractive entry points. Therefore, the question is whether this is a normal correction following the excesses of the pandemic or the end of the cycle. 

Dear Eoin, In the 1960s and 1970s subscribers to the David Fuller Chart Service received a booklet containing hundreds of charts each week or each month. I used to come into the office at 6a.m. and complete the point and figure charts each day. Thanks to this work, I gained a reputation among my colleagues for being the first one to spot changes in the long-term trends of both overall markets, sectors and individual shares. As of this morning, I am getting up one hour earlier and I will start by looking at all the daily charts of the Autonomies in the Chart Library. Let's hope that this will produce the same result. This morning's work show very small blue upward marks in almost every chart. These are tiny upward movements in the year-long major decline in all these share prices. This "summer's swallow" has not yet started chirping. Regards,

Thank you for this account. David was still having chartbooks printed in 2003, when we began working together. By that stage they were a very niche product that had become obsolete with the development of charting software. Nevertheless, the practice of looking at lots of charts is as useful today as it has ever been.

In following your program of activity, I would suggest taking one day to look at point and figure charts. They will give you clear confirmation of a change of trend.

Even if new buyers step into purchase these bonds, they’re likely to demand a higher yield for doing so — potentially adding to government deficits and mortgage rates at a time when they’re already soaring.

“All this points to a somewhat higher resting level for the mortgage/Treasury basis—and potentially for other related assets like IG corporates, which finally caught up with some of the mortgage widening over the past few days,” the analysts conclude.

2-year yields at over 4% are sufficient incentive to drag cash into the sovereign markets. When the alternative is to lose double digits in the stock market and see cash eroded by inflation, the allure of a guaranteed 4% is reason enough to invest.

The price of deeper out-of-the-money insurance in equities is falling, implying lower demand for
crash insurance. This suggests the market believes the Fed put is getting closer.

A conundrum all year has the been the relatively low level of the VIX despite equity markets being in a bear market. The VIX has been low relative to implied volatility, relative to longer-term volatility, and remains low compared to cross-asset volatility. Most notably, though, the VIX has been low -- and
continues to fall -- versus at-the-money volatility.
 
This is due to the price of further out-of-the-money put options falling by more than options that are less out of the money. We can see this by looking the difference in volatility between 80% and 90% out-of-the­-money put options and see it has been falling.

As the VIX is a weighted average of all S&P options with approximately 1-month to expiry and that have a non-zero bid, the lower price of these deeper out-of-the-money options is keeping the VIX lower relative to at-the-money volatility than it otherwise would be.

Puts have still been in demand though. The put/call volume ratio has been rising, showing that investors are buying more puts relative to calls. But the put/call price ratio has been falling, showing that investors have been paying relatively less for those puts.

Investors have therefore not been paying up as much for crash insurance, and buying puts that are less out of the money. The Fed is now well into its hiking cycle, and the market is inferring it believes the Fed put is getting nearer.

Certainly, current oversold conditions suggest a short-term bounce is at hand. But while excess liquidity remains depressed, it will be hard for the market to make new highs. The Fed put may be closer, but that does not mean the bear market is over.

No two crises are the same and yet the temptation to think “this time is different” has been proved wrong on so many occasions that the term is a cautionary tale. The Bank of England intervened to support the domestic pension system this week. Several schemes required £100 million in additional capital each and others were looking at closing. The central bank had no choice but to wade in and provide some stability. The ramifications of this move raise more questions than answers.

I've spent some long days and nights this week on this very subject (work as an investment actuary in DB [Ed. Defined Benefit] pension fund space)...

Fiscal policy context: mini-budget, with expected energy price cap but surprise revenue cuts (tax, NI, duty, etc.); cost of the latter might be in the vicinity of c£40bn pa (without OBR numbers its hard to say though).

Monetary policy context: TBC regarding rate hikes from November MPC meeting; QT expected to be of the order of c£80bn over next 12months, in an effort to combat inflation. So we have fiscal loosening amid a longer term aim from the BoE to tighten.

As above, the surprise cuts cost, and the DMO has therefore had increase it's expected gilt issuance significantly. This huge increase in supply led to an increase in gilt yields, which move inversely vs price and hence inversely vs relative demand. But, that was only the start...

DB pension schemes facing substantial deficits post-GFC typically have portfolio divided into two parts:

one part seeks excess return in order to make good the deficit
the other part "hedges" the liabilities, which behave like typically long duration bonds (insomuch as they have interest and inflation sensitivities) - their long duration makes them susceptible to quite large changes in value (e.g. 20y duration with a 1% increase in rates at that duration would lead to a 20% fall) - it's therefore a good idea to minimise risk, but you need to minimise risk relative to your specific liabilities (i.e. jurisdiction, duration, realness, etc.)

But, if you're trying to hedge 100% of your liabilities (or even something less) with <100% of your assets (in practice this number is often in the 25-50% range), then you need to use leverage. Two (not exhaustive) ways of gaining exposure to interest rates and inflation using leverage are: 

To enter into swaps whereby I agree with you that I'll pay you x% each period and you'll pay me whatever a floating interest rate or inflation is. I haven't actually bought anything in doing so and therefore haven't actually used any money = leveraged exposure

Another option is that we use a "repo". I sell you my gilt on the understanding that I'll buy it back on a known future date at a specified future (higher) price. In other words, I am paying to borrow over the period whilst still exposed to the price move of the asset repo'd. With that borrowing I can go and buy another gilt. I've therefore effectively doubled my exposure to gilt price moves = leveraged exposure.

In practice, to ensure that these synthetic hedges don't pose excessive credit risk either way, you are usually required to maintain a pool of collateral (the gilt in the repo, or a pool of assets backing a swap portfolio).

With both these techniques, if rates rise/fall, then the value of my liabilities falls/rises. So too do my assets. If I had used these synthetic techniques to ensure my asset sensitivity = liability sensitivity then the move will be similar on both sides, so my deficit won't have changed.

So, what's the problem? As yields rise, the value of my gilts fall. So, when I close out the positions on a repo for example: I make a loss on the second gilt; I then can't repay the lender in the repo arrangement. You can see how this ends if I hadn't repo'd once, but more...

That means then that when yields rise people are forced to close out positions and you end up with a load of gilts sold. Those additional sales push the price down further (DB funds are massive players in the gilt markets - less so in other risk asset markets - so move prices materially). This forces those next up the chain to close out, pushing the price down further. Repeat. You end up in a spiral that collapses pretty spectacularly and pretty quickly.

The only way to avoid having to close out in such situations is to keep posting more collateral. But, that means selling those assets you're using to seek excess returns. Can you do that quickly enough, allowing for settlement times and the necessary transfer of cash over to your leveraged gilt portfolio? Normally yes when markets are moving gradually, but not in the last week and certainly not in a fully fledged spiral sell-off.

So far, it's not a pension fund solvency issue - just a liquidity one - they have the cash/liquid assets but can't put them to work in time. But, you really don't want to be the last one out in these spirals as you come out at the worst price without much ability to get back in for the ride back down (in yields/up in prices). You either want to be out from the start or in all the way and still in at the top. If you do end up closed out in the spiral, then you most likely will struggle to buy back in before yields fall. And that is where the long term damage is done: when yields fall back down, the value of your liabilities is going back up, but you no longer have the hedging assets to match that rise, so your scheme funding worsens.

In this week's episode, we eventually saw the BoE step in. Probably a day late and after much pressure, but understandable given to calm things they are committing to buying gilts to whatever extent is necessary - effectively QE, and the opposite of what they are trying to do medium term to curb inflation. But, their purchase has calmed things substantially, so that's good. It's just unfortunate that there will have been some casualties on the way - we'll find out over the coming days. There will be large variation: those that were "underhedged" a month ago will have won big time; those that were forced sellers immediately before the BoE statement will be big losers; others will be somewhere between.

Here's the 20y nominal gilt yield. You can very clearly see when the budget was and when the BoE stepped in around 11am this morning. Worth also flicking to "all" to see quite how sharp this is in historical context. 

When people talk about how central banks have distorted the fixed income markets this is a perfect example. Pensions need reliable returns to meet their obligations. That’s especially true of defined benefit programs which occupied 45% of the UK market in 2019. The alternative to goosing returns with leverage or moving further out the risk curve into private assets.

The price of refusing to take these risks would be to demand much higher contributions to cover the shortfall and nobody wants to do that. Faced with the possibility of angry retirees, at the prospect of not receiving their dues, or relying on the central bank to bail them out, the answer is always going to be the latter.  Quantitative easing introduced significant moral hazard and yesterday Bank of England action, while necessary, compounded it

Let's do a little rule of three.
Debt service is now at about three percent of GDP per year and the ECB can no longer manipulate Italy's rates downward, to keep Italy's head above water, since the US is raising its rates.
On today's growth figures (which will fall), and with interest rates rising over the next five years, debt servicing will rise to six percent of GDP, which means that the standard of living of every individual will fall by at least three percent, which is impossible.
And there is no solution as long as Italy remains in the Euro, and everyone in Italy knows this.              
And Italy can easily get out because it has a primary budget surplus and a trade surplus. It does not need the financial markets to make ends meet, unlike France.
In any case, make no mistake: the Italian elections are about one thing and one thing only: the euro. "Always think about it, never talk about it" seems to be the watchword in Italy.
And so, the more "right-wingers" are elected, the higher the probability that Italy will abandon the euro.

Yield curve control is the topic of the moment. The UK has just introduced it, so the logical question is which jurisdiction will deploy it next. In this regard, Japan’s refusal to abandon its program looks particularly inspired. Another way to frame this question is what will Germany do to ensure everyone continues to use the Euro? So far, the answer has been whatever is necessary.

Congrats on your opinion on a larger correction and acting on it with put purchases.

Last week Double Line presentation  had a chart that showed the performance of equity and the different credit subclasses, Ags., EM, HY, ClOs and so forth. Showed  the large move by equities compare to credit over the same time period. It made me wonder how much further the equity correction can go.

You often follow interesting companies, you mention EQNR from Norway. have you ever looked a Freyr. It is also Norwegian and is involved in batteries. During  the last days because of a report on its possible growth it had a huge move , but during this correction it may be a good opportunity, let me have your thoughts. Based on your comments  how much the market has already priced in the EVs maybe it is not a good idea.

The move on copper is not a good signal  

Trust all is well for you  and your family

Thank you for these well wishes and questions which may be of interest to the Collective. Of my nine different long-dated put positions, the only one not in profit is Tesla and yet that is the one I have the greatest hopes for. They all have maturities in 2024, but I expect the point of maximum pessimism will arrive while they still have some time value.

Brookfield is looking to multiply its current 4 GW renewable portfolio by 3 to four times in India within the next decade in generation as well as help corporates make the transition to decarbonise and invest in building large scale supply chain in the country, said a top executive.

The renewables current assets under management is approximately $1 billion.

Earlier this year, Brookfield Asset Management announced that it raised a record $15 billion for its inaugural Global Transition Fund. This marks the world's largest private fund dedicated to the net zero transition, signaling that investors are still committed to establishing cleaner portfolios. Brookfield is the single largest sponsor of the fund having deployed $2 billion itself.

Brookfield deals with state utilities but sees incremental green power demand coming from corporates who are increasingly becoming bulk consumers. For example, as part of its road map to achieve 100 per cent dependence on renewable energy by 2025. Amazon on Wednesday announced its first utility-scale projects in India — three solar farms located in Rajasthan. These include a 210-megawatt (Mw) project to be developed by India-based developer ReNew Power, a 100 Mw project to be developed by local  developer Amp Energy India, and a 110 Mw project to be developed by Brookfield Renewable Partners.

Brookfield is the name that comes up in almost every conversation I have with investors. The name is treated reverentially because the team so artfully plotted a route through the Global Financial Crisis and the subsequent boom.

on today's video you highlighted the virtues of the NOBL Dividend Aristocrat index, but on closer inspection the yield on this is just 2%. A year ago, that was 4x the yield on short term treasuries in the US, but with 1 and 2- year treasuries yielding 4% now, double that of NOBL, there seems to be far less support from those seeking out yield.
The TINA approach is fast coming to an end. With that in mind, and with the Sterling continuing to take strain, what investment vehicles are available to us in the UK to invest in 3M, 1Y an 2Y US Treasury paper?

Thank you for this question which may be of interest to the Collective. There is of course a big difference between capturing a high yield now and buying with the expectation of dividend increases in future. It is essentially the difference between current yield and yield to cost.

I have been thinking a lot about the aspects of the market we all tend to take for granted. The types of conclusions we have been conditioned to draw, because that is always how markets work. It strikes me as a big question because we should be asking if these market norms are the result of the decades-long process of disinflation or are they rules that transfer between big secular themes.

The basic working hypothesis of the markets is the Fed will rescue its stock market. The EU will rescue its bond market and China will rescue its property market. The rationale for all three is the same. That’s what they have always done because those are the biggest asset classes owned by consumers in all three jurisdictions.

In the Big Picture Roundup, you shared this wonderful chart.

The problem is that the way that you shared it, means that we could not see the date axis.

It would be great if you could share a better version of this chart e.g., on Comment of the Day

Thank you in advance

Thank you for pointing this out. The aspect ratio between my monitor and the recording software is not always one to one. Here is the chart you were asking about.

What I like about this chart is it starts in 2000. It graphically illustrates that some property markets completely sidestepped the housing crash associated with the global financial crisis in 2008. These same markets, notably Australia, Canada, New Zealand and Sweden are expensive on a price/income and price/rent basis.

The global economy may face a recession next year caused by an aggressive wave of policy tightening that could yet prove inadequate to temper inflation, the World Bank said in a new report.

Policy makers around the world are rolling back monetary and fiscal support at a degree of synchronization not seen in half a century, according to the study released in Washington on Thursday. That sets off larger-than-envisioned impacts in sapping financial conditions and deepening the global growth slowdown, it said.

Investors expect central banks to raise global monetary policy rates to almost 4% next year, double the average in 2021, just to keep core inflation at the 5% level. Rates could go as high as 6% if central banks look to wrangle inflation within their target bands, according to the report’s model.

When quantitative easing was first introduced there was a lot of handwringing at the thought of moral hazard. The Federal Reserve waded into public markets to buy sovereign bonds with the stated aim of back stopping government spending and encouraging speculation. It was viewed as a very risky endeavour that would send the wrong signal to speculators; that they can’t lose. In 2012/13 the EU went in the opposite direction and withdrew liquidity for fear that debtor nations would not mend their ways if assistance was too generous. 

Dear Eoin, I may not be the only Europe-based investor who is currently facing the following dilemma. My income and expenditure are both in Euros. I have protected and increased my wealth and income by investing in USA stocks which have given me both capital appreciation and currency increase. Now the USA dollar looks over-valued and all equity options appear to be unfavourable. In addition, inflation is high and so holding liquidity means losing real spending power. What are the alternatives on offer?

Thank you for this question which touches on a topic everyone has an interest in at present. Inflation has been described as the thief which comes in the night, but lately it feels like bandits are roaming around the house in broad daylight.

I think it looks like interest rates will have to rise a lot (toward the higher end of the 4.5 to 6 percent range) and a significant fall in private credit that will curtail spending. This will bring private sector credit growth down, which will bring private sector spending and, hence, the economy down with it.

Now, we can estimate what that rise in rates will mean for market prices and economic growth. The rise in interest rates will have two types of negative effects on asset prices: 1) the present value discount rate and 2) the decline in incomes produced by assets because of the weaker economy. We have to look at both. What are your estimates for these? I estimate that a rise in rates from where they are to about 4.5 percent will produce about a 20 percent negative impact on equity prices (on average, though greater for longer duration assets and less for shorter duration ones) based on the present value discount effect and about a 10 percent negative impact from declining incomes.

Now we can estimate what the fall in markets will mean for the economy i.e., the "wealth effect." When people lose money, they become cautious, and lenders are more cautious in lending to them, so they spend less. My guesstimate that a significant economic contraction will be required, but it will take a while to happen because cash levels and wealth levels are now relatively high, so they can be used to support spending until they are drawn down. We are now seeing that happen. For example, while we are seeing a significant weakening in the interest rate and debt dependent sectors like housing, we are still seeing relatively strong consumption spending and employment.

The upshot is that it looks likely to me that the inflation rate will stay significantly above what people and the Fed want it to be (while the year-over-year inflation rate will fall), that interest rates will go up, that other markets will go down, and that the economy will be weaker than expected, and that is without consideration given to the worsening trends in internal and external conflicts and their effects. 

US rail workers are about to go on strike. By now the pattern is familiar. The companies they work for are making record profits and the wages have not kept up with inflation. This will also again highlight the disparity between the benefits of union workers versus less well represented groups. This is exactly the kind of evidence of a wage price spiral the Fed is seeking to avoid by hiking rates aggressively.

US consumer prices were resurgent last month, dashing hopes of a nascent slowdown and likely assuring another historically large interest-rate hike from the Federal Reserve.

The consumer price index increased 0.1% from July, after no change in the prior month, Labor Department data showed Tuesday. From a year earlier, prices climbed 8.3%, a slight deceleration, largely due to recent declines in gasoline prices.

So-called core CPI, which strips out the more volatile food and energy components, advanced 0.6% from July and 6.3% from a year ago, the first acceleration in six months on an annual basis. All measures came in above forecasts. Shelter, food and medical care were among the largest contributors to price growth.

The acceleration in inflation points to a stubbornly high cost of living for Americans, despite some relief at the gas pump. Price pressures are still historically elevated and widespread, pointing to a long road ahead toward the Fed’s inflation target.

Inflation probably has peaked but that is not a commentary on how quickly it comes back down. The bullish narrative for inflation is that the pandemic was an anomaly. The surge in inflation was created by supply shocks and liquidity-fuelled asset price appreciation. With the end of the pandemic and less money supply, inflation will fall back as quickly as it rose, so buy the dip.

After the discussion around earnings trajectory for the S&P 500, the focus then typically turned to how to trade it. Here, we have some sympathy for the view that markets may potentially hold up very tactically until the EPS cuts actually happen. As already noted, conference season is upon us and investors are ready for some bad news at least with regard to how 3Q is progressing. However, the degree of that deterioration is more debated now given the recently announced $500 billion student debt forgiveness and extended moratorium on loan payments until December, combined with the energy subsidy announced this past week in the UK to help consumers through the winter. Both of these are rather large fiscal stimulus packages that could keep the "tone" of company commentary less bearish than feared, and potentially delay the eventual cuts. Nonetheless, we have high conviction that EPS cuts will play out in earnest over the next 2-3 months, and as a reminder from our note last week, mid-September through October is a particularly challenging seasonal period for EPS revisions.

The yield curve (10-year – 2-year) inverted for a week in April and has been persistently inverted since June. The classic version of the yield curve (10-year – 3-month) is not yet inverted but it is still trending lower. This spread collapsed from an artificially elevated level in May. It tends to be much more volatile than the longer-dated version because short-term interest rates can whip around a lot.  

Actually, it all started moments before the ECB released its policy statement. The euro dropped like a stone by around 40 pips in a move that got me wondering whether there had been a leak. Most likely, it’s one of those trades that was going to be very directional, but it’s telling that the move was bearish the euro when most expected a jumbo hike and shows that investors expect the euro to remain under pressure, with high conviction on the trade.

Then came the unprecedented interest rate increase. And for everyone that expected some lively action, it seemed that screens were frozen. Little reaction from the common currency, same picture with the bond monitors. Was it down to some great communication by the ECB that there was little reaction? Or did the market just wait for more info before trading in size? The answer came a few minutes later when euro area bond yields felt some pressure as the decision by the Governing Council was unanimous.

It became totally evident when short-end yields led a double-digit advance across the curve and the euro didn’t budge. The current narrative goes that there’s little the ECB can do to support the euro given the energy crisis. And especially if inflation remains supply-driven in the euro area, higher rates won’t do the trick. Not as much as they can do for a demand-driven inflation, like the one in the US, as Lagarde said. After all, there’s been a deep breakdown of the correlation between the common currency and bond yields since mid-August, and yesterday just highlighted this divergence. Given natural gas prices fell to the lowest in almost a month as politicians draw plans to intervene in regional markets, it could be that the euro manages to set a medium-term bottom soon.

The ECB only has one mandate which is to control inflation. It has taken on a wide range of additional responsibilities over the last twenty years but the central mandate to target a 2% rate has not changed. 

Of course, they never accounted for the possibility of mass hysteria among the ruling class during a pandemic and a war on the border of the EU shortly afterwards. 

Thanks for another very informative comment of the day. do you expect the SP500 to test the lows of 2020? I would very much like to hear your views on this. Thanks in advance. Best rgds.

Thank you for this topical question. As a repeat delegate at the Chart Seminar, you will remember that targets are more a reflection of personal bias than an accurate predictor of where prices are likely to trade. Since I am short the Nasdaq-100 I am keenly aware of the influence that has on my personal psychology and that is likely to affect how I view downside potential. Let’s look at the chart facts.

According to a Bloomberg News report, Truss has drafted plans to cap annual electricity and gas bills for a typical household at or below the current level of £1,971 ($2,300). That would have a significant impact on inflation, which our baseline scenario forecasts will reach 15% in January. Mechanically inputting the cap freeze into our forecast shows inflation peaking in July (at 10.1%) and then falling back at a faster pace -- approaching 2% within a year.

The cost of implementing that measure would be a whopping £130 billion over the next 18 months, according to Bloomberg News. If we then add fresh support to businesses, which may total £40 billion based on draft government plans, the full size of the package could reach 7% of GDP. That’s a massive fiscal boost, close to the level of government support seen during the pandemic.

But it’s early days. There’s a high probability that the reported plans will face significant push-back from the Treasury or from within the Conservative Party -- especially as these measures would be poorly targeted. A key question will be how the energy cap is funded. It could be clawed back from households later, keeping energy prices higher for longer, or purely financed by government borrowing. The latter option would create a significant hole in the government’s finances -- even if the cap delivers around £30 billion of savings from lower inflation-linked debt payments in 2023-24.

Another possibility is the government intervening in wholesale energy markets. That could dampen the impact on the public finances, because it would open up the possibility of reducing bumper profits from some electricity producers. The snag here is it would be akin to a windfall tax, which Truss has previously said she would not pursue.

7% of GDP is a lot of money to spend on standing still. The fact the £170 billion price tag coincides almost identically with the excess profits for energy companies quoted last week. It suggests the government is aware of what sector can be targeted should financing this stimulus become an issue.  

Aside from fanning inflation, the biggest energy crisis in decades is sucking up capital to guarantee trades amid wild price swings. That’s pushing European Union officials to intervene to prevent energy markets from stalling, while governments across the region are stepping in to backstop struggling utilities. Finland has warned of a “Lehman Brothers” moment, with power companies facing sudden cash shortages. 

“Liquidity support is going to be needed,” Helge Haugane, Equinor’s senior vice president for gas and power, said in an interview. The issue is focused on derivatives trading, while the physical market is functioning, he said, adding that the energy company’s estimate for $1.5 trillion to prop up so-called paper trading is “conservative.”

Many companies are finding it increasingly difficult to manage margin calls, an exchange requirement for extra collateral to guarantee trading positions when prices rise. That’s forcing utilities to secure multi-billion euro credit lines, while rising interest rates add to costs.

“This is just capital that is dead and tied up in margin calls,” Haugane said in an interview at the Gastech conference in Milan. “If the companies need to put up that much money, that means liquidity in the market dries up and this is not good for this part of the gas markets.”  

The ECB is looking primed to begin hiking rates while at the same time it will also be prevailed upon to provide significant additional liquidity. This is akin to taking with one hand and giving with the other. Even that’s a stretch.

Thanks for joining us as we took you through the results of the Conservative leadership race. Liz Truss will take office Tuesday and give a speech outside her new home -- No. 10 Downing Street. In the meantime, these are the key takeaways so far:

Liz Truss won the race to be the UK’s next prime minister, but achieved a smaller-than-expected margin of victory over Rishi Sunak, with 57.3% of Tory members’ votes.
She vowed to cut taxes, grow the economy, and address the crises in energy and the National Health Service.
Truss will visit Queen Elizabeth II in her Scottish castle to be formally appointed on Tuesday, after which she will make a speech to the nation and appoint members of her cabinet.
She inherits a forbidding in-tray: surging inflation, predictions of a recession and a record squeeze on living standards spurred by soaring energy prices.
Truss has promised to announce how she would help Britons through the cost-of-living crisis in her first week -- reports suggest she could freeze energy bills and offer targeted financial help to low-income households and pensioners.

The Pound and Gilts have sold off aggressively over the last month as traders priced in the rising potential Liz Truss would succeed Boris Johnson. The most urgent issue is the massive impending jump in electricity costs. No prime minister can survive through that kind of living standard decline, so price caps are inevitable.

My theory is that the breaking of these superbubbles takes multiple stages. First, the bubble forms; second, a setback occurs, as it just did in the first half of this year, when some wrinkle in the economic or political environment causes investors to realize that perfection will, after all, not last forever, and valuations take a half-step back. Then there is what we have just seen – the bear market rally. Fourth and finally, fundamentals deteriorate and the market declines to a low.

Let’s return to where we are in this process today. Bear market rallies in superbubbles are easier and faster than any other rallies. Investors surmise, this stock sold for $100 6 months ago, so now at $50, or $60, or $70, it must be cheap. Outside of the late stage of a superbubble, new highs are slow and nervous as investors realize that no one has ever bought this stock at this price before: so it is four steps forward, three steps back, gingerly exploring terra incognita. Bear market rallies are the opposite: it sold at $100 before, maybe it could sell at $100 again.

The proof of the pudding is the speed and scale of these bear market rallies.
1. From the November low in 1929 to the April 1930 high, the market rallied 46% – a 55% recovery of the loss from the peak.
2. In 1973, the summer rally after the initial decline recovered 59% of the S&P 500's total loss from the high.
3. In 2000, the NASDAQ (which had been the main event of the tech bubble) recovered 60% of its initial losses in just 2 months.
4. In 2022, at the intraday peak on August 16th, the S&P had made back 58% of its losses since its June low. Thus we could say the current event, so far, is looking eerily similar to these other historic superbubbles.

Have we seen the secular peak in this market? That’s the only real question investors need to concern themselves with. The above statistics are certainly compelling, but the size of the rebounds should also be considered relative to the size of the initial declines from the peaks. Let’s round out that data.

1. The Dow Jones Industrials Average accelerated to the peak on September 3rd 1929. It fell 47.87% to the initial low on November 13th
2. The peak in 1973 was a failed upside break from a range that had been forming since 1966; with the Dow failing at the psychological 1000 on several occasions. That failed upside break resulted in a deeper pullback than any (25% & 36%) posted during the ranging phase. The failed downside break in 1974 resulted in a 75% rebound. It was another six years before a breakout to new highs was sustained.
3. Between March 10th and May 26th 2000 the Nasdaq Composite fell 40.72%.
4. Between January 7th and the low on June 17th the S&P500 declined 24.52%.

With regard to increasing the pace of QT, the past attempts were undertaken during periods of much lower inflation. With inflation currently much higher, dare I say it, might this time be different?

Thank you for this question which is highly relevant since the Federal Reserve will be doubling the pace of balance sheet run-off to $95 billion a month within weeks. We only have two examples of significant balance sheet contraction by central banks. That was the ECB between 2012 and 2014 and the Fed between 2018 and 2019.

Deutsche Bank estimates that subtracting the rebate will reduce the Retail Prices Index, which determines payments on UK inflation-linked debt, by about 2.7 percentage points. That would lower the debt interest bill by around £14 billion this year, according to Bloomberg calculations based on Office for Budget Responsibility data. RPI is also tied to some consumer products, such as mobile phone tariffs.

Such savings would be welcomed by the government, which is under intense pressure to spend even more in response to the surge in energy costs. A similar reduction in the Consumer Prices Index, and a potentially lower path for interest rates as a result, could also save the government billions.

Based on CPI, UK inflation is already above 10%. The Bank of England forecasts that it will top out just above 13%, although a surge in gas prices in recent weeks mean officials will almost certainly have to increase that forecast. That means the ONS decision may impact the peak rate this winter, but not change the direction of the outlook for prices. 

Persistent inflation has a long tail. The longer it lasts, the greater the effects for government finances in future. Index-linked pensions, tariffs and utilities all push higher with a lag from a current bout of inflation. That’s both a near-term headache and medium-term challenge for most governments. That greatly increases potential for government intervention. It is starting with subsidies and will quickly transition to price caps if prices fail to decline.  

The price of Germany’s electricity over the next year has climbed over $1000pb in Brent oil energy equivalent terms. This is far from normal. It’s a crisis that stems not only from restrained energy supply from Russia but a series of unfortunate issues elsewhere too. In addition to energy restraints, the euro area is facing the full brunt of climate change with flash floods and record droughts, combined with slowing trade with China and US recession risks. However, we think the bigger challenge Europe will face this winter is not inflation, but stagflation. Altogether it’s why we expect EUR/USD to fall to 0.90 this winter, inflation to climb further to multi-decade highs before peaking, GDP to decline over the coming year and the ECB to first raise rates in response to higher inflation, and then cut next year as the energy-induced recession continues. Will Germany run out of gas? Probably not. That's due to LNG supply, but even more due to falling industrial demand. High prices and falling demand of an essential such as energy is not good for growth, but it gives hope that blackouts in Germany won't be the story of early 2023.

This report shares the downbeat consensus view that Europe is going to endure a profound winter of discount. There is no doubt the challenges are immense but so have been the efforts to overcome them. For example, the EU has reached its November target for natural gas reserves. That suggests some slowdown in demand following indiscriminate buying over the last few months.

Officials attending the Federal Reserve’s Jackson Hole gathering signaled the ECB is prepared to at least repeat the 50 basis-point hike enacted in July, with some not excluding an even larger increase. Executive Board member Isabel Schnabel urged “strong determination to bring inflation back to target quickly.”

While Lane didn’t spell out whether he’d oppose a 75 basis-point step, his comments suggest officials would need to see the need for a higher “terminal rate,” or high point of the current hiking cycle, for him to support such a move.

The Irish official said a “multi-step adjustment path towards the terminal rate also makes it easier to undertake mid-course corrections if circumstances change.” If new data called for a lower terminal rate, “this would be easier to handle under a step-by-step approach,” he said. 

Among the more cautious voices on the Governing Council is Executive Board member Fabio Panetta, who said last week that policy maker must tread carefully as a significant economic slowdown would ease inflationary pressure. 

The ECB has one of the most out of control inflation problems in the world. The pressure being exerted on the region from Russia’s energy war is not about to disappear. However, the successful filling of gas storage facilities ahead of schedule will moderate the risk of shortages this winter.  

With just 10 days to go until Boris Johnson’s successor as premier and Conservative Party leader is announced, neither candidate has detailed how much assistance they’ll provide to families and businesses who face soaring energy costs, despite Chancellor of the Exchequer Nadhim Zahawi conceding that the current support package is “not enough.”

Whichever candidate wins the Tory leadership contest, addressing the impact of rocketing energy bills will be at the top of their in-tray after Ofgem said on Friday that a price cap on average annual energy bills would rise to £3,549 ($4,206) in six weeks’ time. That’s 178% higher than last winter and 80% more than at present. 

The only questions considered are how much support to provide. Fiscal discipline is out of favour at present. With inflation and energy prices hitting living standards so aggressively, the UK government is under extraordinary pressure to ease the pain.

Any sign from this week’s Jackson Hole symposium of more aggressive rate hikes to come will whack credit markets, which have already started to give back summer gains. Misplaced optimism about the US inflation and economic outlook squeezed spreads to unsustainably tight levels, leaving debt vulnerable to a fall that will be exacerbated by dwindling liquidity.

US high-grade bonds got overbought as fund inflows chased better returns, despite a barrage of issuance which will likely resume in September. The high-duration debt stands to lose most from a more hawkish Fed.

Spreads have almost 25 bps to go before hitting the July wide at 160 bps, but investors are keeping powder dry for a move back to May 2020 levels above 180 bps. That would be a fairly extreme move for a market that tends to move in 1-2 bps daily increments, but pre-Labor Day lack of liquidity provides scope to gap out.

Junk’s summer gains were led by the riskiest bonds, which would be battered most by a higher rates/lower growth environment. Some are waiting for a pummeling to 800 bps -- from 432 bps currently -- before buying in.

The biggest factor in the underperformance of portfolios from the beginning of the year had been the strong correlation between bonds and equities. They both fell at the same time and played havoc with the 60/40 portfolio set up. That relationship stopped working from early this month. Treasury prices resumed falling but stock prices rebounded.

We have a large number of people who are estranged from our economy. In 1960, 5% of men were not working between the ages of 25 and 54. Today it’s more like 15%. If 15% of men are not working at any point in time, then a quarter of the people will have been out of work for a year or more over a four or five-year period. That’s destructive to the economy's productive potential. It’s destructive to their families. It’s destructive to the areas in which they live. It’s destructive to the moral fabric of our national life.

I recently finished reading Coming Apart by Charles Murray. It’s a harrowing account of how the polarization in the economy is manifested in a growing rift between the privileged, insulated upper class and a benefits-dependent underclass.