The Bank of England Kerfuffle

The BoE blinked first. Let’s parse this out. Were you forwarded this email? [Sign-up to Rude Awakening here.]( [The Rude Awakening] September 30, 2022 [WEBSITE]( | [UNSUBSCRIBE]( The Bank of England Kerfuffle - New UK Chancellor of the Exchequer, Kwasi Kwarteng, announced his mini budget on September 23rd. - The markets reacted severely and sent UK government bond yields through the roof. - This put many UK pension funds on the edge of bankruptcy, so the Bank of England stepped in. Recommended Link [Military Experts preparing for a “Pearl Harbor Style Attack” on Guam?]( Putin invades Ukraine… China launches rockets over the straits of Taiwan… And as we speak, military experts are warning the US to “Prepare for a Pearl Harbor Style Attack” on Guam. [Is the beginning of World War III?]( But more importantly, there is an [exact playbook]( on what is playing out in the world and what you need to do to prepare. [Simply click here now I’ll show you how to claim your copy]( [Click Here To Learn More]( Sean Ring Editor, Rude Awakening Happy Friday to you! But before we get all festive, the pictures from Hurricane Ian are frightening. If you have any friends or family living near Fort Meyers, Florida, I hope they’re ok. Now, to this discussion. I wrote earlier that I’d include a “Bank of England” section in Monday’s Monthly Asset Class Report. But after looking at the charts, I’ve concluded there’s already enough “stupid” in there. And though I lived in the Big Smoke - that’s London - for nearly ten years, I don’t pay much attention to UK monetary policy anymore. I don’t own any UK assets; I don’t even have a British bank account anymore. My good friend and colleague, Dan Amoss, gave an excellent explanation on our Wednesday editorial call. Unfortunately, I was late to the call and missed it! (Punctuality still matters, especially when super-smart guys like Dan hold court.) So, I was trundling through LinkedIn to figure out what happened there. Luckily, I have many colleagues in the financial training industry whose jobs are to teach bankers like the bankers are toddlers. (Insert joke here.) One such friend, Ryan Spendelow, Director of Asia-Pacific at MDA Training, offered a gem of an explanation. I’ll reprint that here, interjecting when terms unfamiliar to American and other non-UK investors crop up. I know Ryan from my days in Hong Kong. He’s a great guy and sings for his supper. So, I don’t mind shelling out for the beers next time I’m in the Fragrant Harbour (yes, with a “u.”) Here we go… Ryan Begins From Ryan: I’ve had a few DMs and emails asking me to try and explain (simply) what’s happening in the U.K right now. I’ll try and explain it in a way my (admittedly very bright) six-year-old daughter would understand. As Albert Einstein once said, “If you can’t explain it simply, you don’t understand it well enough.” Ryan Sets the Table Again, from Ryan: The Bank of England is saying “borrowing costs are going up” due to inflation (the same inflation they said 18 months ago was transitory!) The Conservative government, by cutting taxes, is saying ‘let’s borrow more!’ So far, so bad. But wait…. there’s more. The Bank of England was certainly correct that borrowing costs are going up. But not about the “transitory” part… Here’s a snapshot of the 10-year UK government bond. Notice the 50% increase in yields - from 3.0% to 4.5% - before the Bank of England intervened. Why did yields spike like that? I see two reasons. The first is that the Bank of England has been raising interest rates to quell inflation. They’ve chased the Fed, but not fast enough. The second is that the UK is now viewed as the worst G10 economy in the world and, thus, a higher risk. The IMF - not a bunch of geniuses, I admit - openly criticized the Chancellor’s package. From [Reuters]( “We are closely monitoring recent economic developments in the UK and are engaged with the authorities," an IMF spokesperson said, in response to a query from Reuters after the British pound hit an all-time low amid spiking market concerns. "Given elevated inflation pressures in many countries, including the UK, we do not recommend large and untargeted fiscal packages at this juncture, as it is important that fiscal policy does not work at cross purposes to monetary policy," the spokesperson said in the IMF's first public reaction. The IMF does have a point, however. If your central bank is tightening by raising interest rates and your government has opened the fiscal spigot, they are indeed working at cross purposes. But not all criticized the Chancellor’s plans. [Allister Heath]( of The Daily Telegraph and [Dan Mitchell]( both ardent free marketeers, lauded the package. Quick note: from now on, I’ll call UK government bonds “gilts.” That’s because they used to have gilt, or gilded, edges, like these playing cards: Credit: [makeplayingcards.com]( Let’s move on to pension funds, where liability-driven investment has gone awry. Recommended Link [CUSTOMER SERVICE: We’re trying to reach you.]( Your important customer care message can be [found here.]( You are by no means required to act on this opportunity. But I believe it’s in your best interest. This will be removed on Friday, September 30th at midnight. You have just days to act. [Please click here for more information.]( [Click Here To Learn More]( The Pension Funds and LDI From Ryan: Pension funds in the UK have more future liabilities (i.e., old people like I’m becoming) than assets coming in (young people investing in their funds). Liability Driven Investment funds solve this problem. LDIs allow pension funds to gain leverage via the interest rate derivative markets to meet this shortfall. The value of these leveraged bets is inversely related to interest rates (bond prices and interest rates tend to move in opposite directions). Interest rates are going up to battle “transitory” inflation, so pension funds are facing massive losses and are getting margin calls. To meet these margin calls, they need to sell bonds, driving these prices lower …. meaning more margin calls. You get the picture. Pension funds now face the risk of insolvency. So far, so very bad. As Ryan says it all, I don’t need to add much color here. Because central banks have held down rates for so long, pension funds couldn’t earn enough through safe investments to meet their future payouts (liabilities). So, pension funds engaged in riskier investments - you’ve probably heard of the term “chasing yield” - to make up for their shortfall. But now, as gilt yields have rocketed, the value of those bonds has plummeted. Those gilts are used as collateral. And if gilts are worth much less, of course, this happens: The Bank of England But the Bank of England can’t let the entire UK pension fund industry fall. The hoi polloi would burn London to the ground. So, the Bank of England panicked and stepped in, to the tune of GBP 65 billion. Ryan concludes: So, the Bank of England has stepped in to buy “unlimited amounts” of government bonds, to keep their prices up, to try and save the pension fund industry. As my 6-year-old asked me, “who has unlimited money, Daddy? They must be private jet rich to afford that.” The UK is not private jet rich. From the [Financial Times]( “If there was no intervention today, gilt yields could have gone up to 7-8 percent from 4.5 percent this morning, and in that situation, around 90 percent of UK pension funds would have run out of collateral,” said Kerrin Rosenberg, Cardano Investment chief executive. “They would have been wiped out.” Wrap Up Thank you to my good friend and Rude reader Ryan Spendelow, whose explanation to his 6-year-old daughter works for 47-year-old men like me. It’s about as simple an explanation, with some notes, for 1,200 words and some coffee. On Monday, the usual Monthly Asset Class Report will be out, untainted by the Keystone Koppery of the UK government/financial complex. It seems like when these people leave Oxford or Cambridge, they don’t get degrees. They get refunds. Have a wonderful weekend! All the best, Sean Ring Editor, Rude Awakening P.S. If you have some spare time this weekend, [watch this video]( of Richard Nikoley and me having a chinwag on YouTube. I’d watch it at 1.5x speed, so you get through it faster. I promise you won’t miss anything if you do. Richard is the author of [FreeTheAnimal.com](. [Nassim Taleb said of his book, also titled Free the Animal, “A charming primer on the paleo idea, with an illustration through the author's own life. I read it in one sitting.”]( [ARCHIVE]( | [ABOUT]( | [CONTACT US]( Rude Awakening is committed to protecting and respecting your privacy. We do not rent or share your email address. By submitting your email address, you consent to Paradigm Press delivering daily email issues and advertisements. To end your Rude Awakening e-mail subscription and associated external offers sent from Rude Awakening, feel free to [unsubscribe](. Please read our [Privacy Statement.]( If you are you having trouble receiving your Rude Awakening subscription, you can ensure its arrival in your mailbox by [whitelisting us.]( © 2022 Paradigm Press, LLC. 808 Saint Paul Street, Baltimore MD 21202. 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