Thanks for the healty dose of reality, sometimes I feel like I'm living in a simulation, with so many people just not realizing what's going on, and maybe thinking (hoping) we will just go back to printing more money soon...
CBs may ultimately choose to.... When push comes to shove, CBs have proven to be the reliable buyer of last resort. Plenty of pain can happen before that point though. I don't think they will message it in the same way, like the BoE who made great effort to distinguish a "financial stability intervention" from a "monetary policy decision", though there is no difference in practice.
Exactly - I think the goal is to avoid a bang. Like the difference between deflating a pool toy and popping a balloon, it all comes down to how much pressure is pent up in the object.
Presumably, an orderly destruction of value is less disruptive than a full blown panic where their may be an overshoot beyond what is necessary or rational.
This is why every "pop" is being met with immediate emergency action, even as rates go higher and QT continues.
This is a bloody brilliant article and I wish I’d read it at the time as it explains things so perfectly clearly and way better than my pathetic attempts.
I’m actually going to go a step further and say that I think you have really under-cooked one key element of the analysis as it applies to the UK. The UK has, I think, the biggest defined-benefit pension schemes in the world and they are certainly a huge proportion of investable assets. Since the mid 2000s, pension regulation and accounting has emphasised/ forced Fixed-income heavy asset and liability matching in the name of ‘de-risking’ pension funds. Given a limited supply of index-linked paper, funds have been forced to buy ‘risk-free’ gilts in vast quantities. Not entirely coincidentally, the UK has run ever-increasing deficits since the GFC that have been financed primarily by the funny money of QE or the switch by pension funds from equities to bonds. The result is that UK pension funds have absolutely massive Gilt holdings and, frankly, I can’t see how the entire system isn’t screwed. Meanwhile the politicians have lacked all fiscal discipline and we seem to me now to be teetering on a precipice.
Absolutely, its hard to parse out blame between policy makers, politicians and private fiduciaries, though there is plenty to go around. The ZIRP regime seemed like a good idea to some who thought that money could be debased infinitely without stoking inflation, but it introduced the problems that we now face today.
Yes. My point was simply that your article, which is brilliant and hard-hitting, isn’t hard-hitting enough in a UK context. I’m a Brit, and I am stunned by the casual lack of understanding of the exposure we have.
It is mind-numbing even leaving aside duration considerations in bond investments to lend someone money for 0.50% for a 40-year-term. Seeing value being destroyed by the badly veiled idiocy the central bankers coined as "Q.E." - it must become clear that the inflection point has already been reached in the issuance of money as a measure of value.
It is now only created out of thin air to paint over the ever-increasing cracks of the dam holding back what's left of monetary policy.
The amount of near-catastrophical disasters is mounting rapdily since 2008 opened the floodgates to neverending increase of M2. Before Covid lockdowns we had the 2019 reverse repo spike that was barely contained. This ironically was caused by a lack of cash reserves (!) when we know there's too much of it bascially sloshing around, but as we know tied up in yield-seeking adventures of the risky kind more likely than lying around to cover for payments.
And now, the reverse repo will probably be another problem that will be harder to control since all the cash is now in waiting positions - for higher yields. It was a facility that got overblown by the same Fed / Central Bankers devising it to patch over the dam ready to burst:
Brilliant article! Thank you for breaking down duration in laments terms. Helped me understand and appreciate what is to come since interest rates should only continue to go up.
Great write up! Spot on - pension funds and other "sophisticated" institutional investors bought these long duration bonds hand over fist - utterly maddening.
Excellent analysis. It seems like this was a very well coordinated effort by Central Bankers around the globe to assure asset managers that rates would stay lower for a longer, but Central Bankers have reneged on those backroom deals, pushing rates up, full well, knowing that there would be a crisis inside pensions and insurance companies, which would then spread to brokerage houses, crypto dealers and all other facets of the economic engine. Classic case of problem, reaction, solution, where the Fed and Central Bankers knew what they were doing, full well knowing they would pick things up on the cheap, continue to let the patient bleed out, and eventually nationalize everything. Traditionally stock portfolio managers has been the "Dumb Money", and the bond money has been the "Smart Money". But it seems that we've simply been in a 40-year bull run in bonds, and bond portfolio managers are just as stupid as stock portfolio managers. They are all playing within the confines of the same game. Maybe some bond portfolio managers are now finally starting to realize the game is over. Governments in and of themselves will attempt to nationalize wide swaths of various markets if interest rates continue to increase, which will squeeze all industries, especially energy, to which they can consolidate more power and control, and typical communist fashion. May people find God in these days, and may the free market return with a backed physical precious metals monetary system!
I would certainly agree that there was a more-than-tacit direction from central bankers to asset managers to buy bonds at any price, as CBs promised lower for longer. I also agree that that CBs are now aware of the effect that rates will have on financial markets and the real economy, but have little choice but to move forward to make up for their sluggish start. Finally, I agree that government and CBs will seek greater control over markets as they continuously expand their "toolkits" with no checks and balances. I doubt however, than any sort of physically backed monetary system is in the cards.
"Classic case of problem, reaction, solution, where the Fed and Central Bankers knew what they were doing, full well knowing they would pick things up on the cheap, continue to let the patient bleed out, and eventually nationalize everything" --> I suppose what they did not know is the repercussions of flooding the markets with liquidity without understanding that it would encourage capital allocation to speculative investments, that in many occasions do not create value for our society. Even if they do create some value, that might be well ahead into the future and not representative of the the price paid today. What they do not seem to have understood is that the highly complex, worldwide interconnected system - which is actually a feat of humanity that one can look at and admire - is built around maximization of efficiencies and not resiliency. If one player decides to stop playing ball, or if a player has to stop playing ball (the player might be injured, for example) the whole team collapses. In a classic football (you guys call it soccer :) )game, a team can play with 10 players (because of a red card, or because a player was injured when all substitutions had been used) and on some occasions still bring in a win, or a draw against all odds. The team can still do that with 9 players, albeit the odds of achieving such a feat are significantly lower. There comes a point, where it is almost impossible bring in a victory. Our world has so many players, with so many intricate interconnections across geographies, industries, supply chains etc. which are impossible for policy makers to even grasp. The vast majority of the policy makers grew up in a different world and do not necessarily have an incentive to learn about the new one (after all, how many years does one in their 50s still have to really enjoy - I would say around 20-30). Even if they do, who says they can?
Thanks for an elucidating article. So many people have a hunch that the individuals at the top are not proper grown-ups. You explain why very well. Cheers to you sir
>coincidentally was the focus of last week’s post, The Furnace.
Pull the other one, that post was about as coincidental as your posts on the Chinese banking system :P
>This particular bond was issued in October 2020 with a coupon of 0.50%. Allegedly sane, sophisticated investors lent the U.K. government money at a fixed rate of 0.50% for forty years. While this sounds like a boring investment, it is an extraordinarily risky bet on interest rates.
I'm getting flashbacks of the CDS contracts issued in 2007. There was nothing sane about the issuers of those contracts.
>The only possible rationale for buying this instrument is the expectation that central banks would continue bidding bonds higher into negative yielding territory - yet another financial perversion of modern monetary policy.
Not my area of expertise, but aren't the buyers (pension funds etc) essentially forced / contractually obligated into buying these securities as supposedly safe instruments? The fund managers aren't exactly allowed to take $2b and throw it into the latest shitcoin. The problem is they're both moving equivalent magnitudes.
The level of randomness in the "coincident" is open to interpretation :)
Regarding forced buyers - I think there is a reality to supply and demand in capital markets. Central banks flooded market with supply (of capital), which drives down the price in the simplest sense. In other words, while individual firms or fiduciaries still have autonomy to construct portfolios, they are bound by the confines of the capital market regime which they don't control. Which is why I put the current predicament more at the feet of CBs who have drove rates towards zero only looking at possible benefits to wealth and growth, while ignoring the risks.
Thanks for the healty dose of reality, sometimes I feel like I'm living in a simulation, with so many people just not realizing what's going on, and maybe thinking (hoping) we will just go back to printing more money soon...
CBs may ultimately choose to.... When push comes to shove, CBs have proven to be the reliable buyer of last resort. Plenty of pain can happen before that point though. I don't think they will message it in the same way, like the BoE who made great effort to distinguish a "financial stability intervention" from a "monetary policy decision", though there is no difference in practice.
Enjoyed the re-read,thanks for reposting.
What is/will be the net difference between deflating and popping the balloon?
Isn’t it just the same but without the bang??
Exactly - I think the goal is to avoid a bang. Like the difference between deflating a pool toy and popping a balloon, it all comes down to how much pressure is pent up in the object.
Presumably, an orderly destruction of value is less disruptive than a full blown panic where their may be an overshoot beyond what is necessary or rational.
This is why every "pop" is being met with immediate emergency action, even as rates go higher and QT continues.
Thanks for the reply Bear
I also particularly liked your phrase. “ Socialising the losses, and Privatising gains”
The smooth gait of your essay (not a critisism) kind of dulls the futility of our situation
This is a bloody brilliant article and I wish I’d read it at the time as it explains things so perfectly clearly and way better than my pathetic attempts.
I’m actually going to go a step further and say that I think you have really under-cooked one key element of the analysis as it applies to the UK. The UK has, I think, the biggest defined-benefit pension schemes in the world and they are certainly a huge proportion of investable assets. Since the mid 2000s, pension regulation and accounting has emphasised/ forced Fixed-income heavy asset and liability matching in the name of ‘de-risking’ pension funds. Given a limited supply of index-linked paper, funds have been forced to buy ‘risk-free’ gilts in vast quantities. Not entirely coincidentally, the UK has run ever-increasing deficits since the GFC that have been financed primarily by the funny money of QE or the switch by pension funds from equities to bonds. The result is that UK pension funds have absolutely massive Gilt holdings and, frankly, I can’t see how the entire system isn’t screwed. Meanwhile the politicians have lacked all fiscal discipline and we seem to me now to be teetering on a precipice.
Thanks Mr. Williams!
Absolutely, its hard to parse out blame between policy makers, politicians and private fiduciaries, though there is plenty to go around. The ZIRP regime seemed like a good idea to some who thought that money could be debased infinitely without stoking inflation, but it introduced the problems that we now face today.
Yes. My point was simply that your article, which is brilliant and hard-hitting, isn’t hard-hitting enough in a UK context. I’m a Brit, and I am stunned by the casual lack of understanding of the exposure we have.
What's discussed here makes way too much sense to be taken seriously.
jk
Ha, thanks Jim!
Wow superb article, thanks TLBS! Your subscription should be mandatory in MBA schools!
I’ve never sat in a MBA class myself so maybe even undergrad!
It is mind-numbing even leaving aside duration considerations in bond investments to lend someone money for 0.50% for a 40-year-term. Seeing value being destroyed by the badly veiled idiocy the central bankers coined as "Q.E." - it must become clear that the inflection point has already been reached in the issuance of money as a measure of value.
It is now only created out of thin air to paint over the ever-increasing cracks of the dam holding back what's left of monetary policy.
The amount of near-catastrophical disasters is mounting rapdily since 2008 opened the floodgates to neverending increase of M2. Before Covid lockdowns we had the 2019 reverse repo spike that was barely contained. This ironically was caused by a lack of cash reserves (!) when we know there's too much of it bascially sloshing around, but as we know tied up in yield-seeking adventures of the risky kind more likely than lying around to cover for payments.
https://en.wikipedia.org/wiki/September_2019_events_in_the_U.S._repo_market
https://www.richmondfed.org/publications/research/econ_focus/2019/q4/opinion
And now, the reverse repo will probably be another problem that will be harder to control since all the cash is now in waiting positions - for higher yields. It was a facility that got overblown by the same Fed / Central Bankers devising it to patch over the dam ready to burst:
https://www.bloomberg.com/news/articles/2022-09-28/fed-reverse-repo-use-hits-fresh-record-as-investors-hide-in-cash
Indeed! In these exact points have been made at length here:
https://thelastbearstanding.substack.com/p/the-furnace
https://thelastbearstanding.substack.com/p/down-the-drain
Brilliant article! Thank you for breaking down duration in laments terms. Helped me understand and appreciate what is to come since interest rates should only continue to go up.
Glad you found it helpful! The metaphor is how Ive visualize it myself for some time
Great write up! Spot on - pension funds and other "sophisticated" institutional investors bought these long duration bonds hand over fist - utterly maddening.
And borrowed against them
Really well written! Provides crucial context on the magnitude of consequences of the action in the bond market lately.
Appreciate the feedback!
Excellent analysis. It seems like this was a very well coordinated effort by Central Bankers around the globe to assure asset managers that rates would stay lower for a longer, but Central Bankers have reneged on those backroom deals, pushing rates up, full well, knowing that there would be a crisis inside pensions and insurance companies, which would then spread to brokerage houses, crypto dealers and all other facets of the economic engine. Classic case of problem, reaction, solution, where the Fed and Central Bankers knew what they were doing, full well knowing they would pick things up on the cheap, continue to let the patient bleed out, and eventually nationalize everything. Traditionally stock portfolio managers has been the "Dumb Money", and the bond money has been the "Smart Money". But it seems that we've simply been in a 40-year bull run in bonds, and bond portfolio managers are just as stupid as stock portfolio managers. They are all playing within the confines of the same game. Maybe some bond portfolio managers are now finally starting to realize the game is over. Governments in and of themselves will attempt to nationalize wide swaths of various markets if interest rates continue to increase, which will squeeze all industries, especially energy, to which they can consolidate more power and control, and typical communist fashion. May people find God in these days, and may the free market return with a backed physical precious metals monetary system!
☕✝️
I would certainly agree that there was a more-than-tacit direction from central bankers to asset managers to buy bonds at any price, as CBs promised lower for longer. I also agree that that CBs are now aware of the effect that rates will have on financial markets and the real economy, but have little choice but to move forward to make up for their sluggish start. Finally, I agree that government and CBs will seek greater control over markets as they continuously expand their "toolkits" with no checks and balances. I doubt however, than any sort of physically backed monetary system is in the cards.
Thanks for reading!
"Classic case of problem, reaction, solution, where the Fed and Central Bankers knew what they were doing, full well knowing they would pick things up on the cheap, continue to let the patient bleed out, and eventually nationalize everything" --> I suppose what they did not know is the repercussions of flooding the markets with liquidity without understanding that it would encourage capital allocation to speculative investments, that in many occasions do not create value for our society. Even if they do create some value, that might be well ahead into the future and not representative of the the price paid today. What they do not seem to have understood is that the highly complex, worldwide interconnected system - which is actually a feat of humanity that one can look at and admire - is built around maximization of efficiencies and not resiliency. If one player decides to stop playing ball, or if a player has to stop playing ball (the player might be injured, for example) the whole team collapses. In a classic football (you guys call it soccer :) )game, a team can play with 10 players (because of a red card, or because a player was injured when all substitutions had been used) and on some occasions still bring in a win, or a draw against all odds. The team can still do that with 9 players, albeit the odds of achieving such a feat are significantly lower. There comes a point, where it is almost impossible bring in a victory. Our world has so many players, with so many intricate interconnections across geographies, industries, supply chains etc. which are impossible for policy makers to even grasp. The vast majority of the policy makers grew up in a different world and do not necessarily have an incentive to learn about the new one (after all, how many years does one in their 50s still have to really enjoy - I would say around 20-30). Even if they do, who says they can?
Amazing write as always by the Bear!!
This is such a great piece that I came back to read it again after everything that we’ve been seeing with SVB, etc. Well done!
Thanks for an elucidating article. So many people have a hunch that the individuals at the top are not proper grown-ups. You explain why very well. Cheers to you sir
>coincidentally was the focus of last week’s post, The Furnace.
Pull the other one, that post was about as coincidental as your posts on the Chinese banking system :P
>This particular bond was issued in October 2020 with a coupon of 0.50%. Allegedly sane, sophisticated investors lent the U.K. government money at a fixed rate of 0.50% for forty years. While this sounds like a boring investment, it is an extraordinarily risky bet on interest rates.
I'm getting flashbacks of the CDS contracts issued in 2007. There was nothing sane about the issuers of those contracts.
>The only possible rationale for buying this instrument is the expectation that central banks would continue bidding bonds higher into negative yielding territory - yet another financial perversion of modern monetary policy.
Not my area of expertise, but aren't the buyers (pension funds etc) essentially forced / contractually obligated into buying these securities as supposedly safe instruments? The fund managers aren't exactly allowed to take $2b and throw it into the latest shitcoin. The problem is they're both moving equivalent magnitudes.
The level of randomness in the "coincident" is open to interpretation :)
Regarding forced buyers - I think there is a reality to supply and demand in capital markets. Central banks flooded market with supply (of capital), which drives down the price in the simplest sense. In other words, while individual firms or fiduciaries still have autonomy to construct portfolios, they are bound by the confines of the capital market regime which they don't control. Which is why I put the current predicament more at the feet of CBs who have drove rates towards zero only looking at possible benefits to wealth and growth, while ignoring the risks.