In recent times, there have been quite a few financial and macroeconomic events occurring, including uncontrolled inflation problems, the collapse of the UK bond market, energy crisis from the Russia-Ukraine war and OPEC+ oil production cut decision, or a significant liquidity drain following tightening decisions by central banks.
This week's macroeconomics column of Viet Hustler will be a bit special as it is divided into 2 parts:
Part 1- Summarizing the latest news on recent economic and financial events for readers: inflation situation, explanation of gilt crash and margin call of pension funds at UK, liquidity drain and energy crisis.
In which, Viet Hustler wants to analyze the constraints in the triad inflation – public debt – banking crisis.
Inflation in the US and globally
Inflation not yet contained at US:
US September inflation data shows inflation is stuck at high levels and shows no signs of being controlled. Even, some costs are increasing at unprecedented speeds.
Headline CPI increase: +8.2 % y/y (higher than forecast +8.1%)
Core CPI even increased higher: +6.6 % y/y (vs forecast +6.5% & +6.3% of August), increasing at the fastest pace since August 1982.
Core inflation is on a rapid upward trajectory, causing the gap between headline CPI and core CPI to narrow gradually. => Inflation in consumer goods other than energy and food is becoming increasingly severe.
The monthly inflation increase rate continuing to accelerate is the biggest evidence that inflation is not under control:
Headline CPI: +0.4% m/m (forecast: +0.2% | August: +0.1%)
Core CPI: +0.6% (forecast +0.4% | August: +0.6%)
A few notable item groups in the CPI basket:
Housing costs continue to be a burden on residents:
Owners' equivalent rent (in CPI basket) up +6.7% y/y at the fastest pace in history.
Similar scenario for airfare prices: +42.9%, with the fastest increase in history.
And medical costs: +0.8% m/m, also one of the fastest increases in the past decade.
Essential consumer items (utilities, gasoline, food at home and electricity) still rising at very high levels but the increase pace has slowed compared to the previous month (19.9% in September vs +22% of August)…
A few “messages” from FED members after September CPI data:
Price stability is the top priority
Fed rate may rise to peak level of 4.5-5% and maintain at peak interest rate for some time
FED expectations: consumer demand will decrease and unemployment will start to rise
Fed will continue QT, but with appropriate adjustments
1-year and 5-10 year inflation expectations both increased in October per University of Michigan survey.
Next year's inflation expectations: up from 4.7% to 5.1%
5-10 year inflation expectations: up from 2.7% to 2.9%)
Rising inflation trend globally
World average inflation has risen to 10.2%, the first double-digit increase since this data was tracked.
Rising inflation will entail consequences for global income distribution: between households and companies with pricing power; from commodity importers to exporters.
Global real disposable income squeezed to unseen lows:
Latest update on energy crisis
Last week, Viet Hustler updated readers with the latest information on the energy crisis in US and Europe in the article:
Energy crisis escalates after OPEC+ oil production cut decision
In Europe, governments have introduced early policies to stabilize energy prices (though unlikely to be effective amid current supply cuts).
LNG exports (liquefied natural gas) from the US surge, especially to Europe:
The US will not face an energy crisis as severe as Europe after OPEC+ cuts oil production.
US oil imports from North and South America have increased rapidly since 2015 in the US effort to avoid oil dependence on OPEC.
(Previously, in the 1970s, the United States imported 70% of its oil and 85% of crude oil from OPEC)
In 2021, Canada supplied 51% of the total US petroleum product imports and 62% of total crude oil imports.
Gilt crash: Explanation of the bond crisis in the UK and the margin call event of pension funds.
The recent collapse of the UK gilt (Treasury bond) market has highlighted the influence of inflation and fiscal monetary policies on capital markets and government debt.
Summary of the Gilt Crash event:
On 09/23, the UK Prime Minister announced a government spending plan up to 7% of UK GDP, including tax cuts and energy subsidies.
However, this fiscal policy is likely to push UK public debt to 103% of GDP in 2023 (from 96% of GDP in 2022) and further widen the government budget deficit, while the BoE is still implementing QT.
This caused a crisis of confidence in the market:
The British pound plunged against the US dollar on 09/23 (-3.5%), reaching the lowest level since 1985.
Yields on 30-year UK government bonds (Gilts) quickly rose above 5%, matching the peak of the 2008 financial crisis.
After the BOE announced plans to buy long-term bonds, 30y gilt prices tended to decrease.
However, on Wednesday last week (10/12), the BOE confirmed it would stop all market interventions.
Immediately after, investors continued to sell gilts, causing 30-year gilt yields to surge back to nearly 5% again.
Therefore, the BOE had to conduct an emergency purchase of 30y gilts of unprecedented value: 4.56 billion GBP (~5.1 billion USD), bringing the 30-year gilt yield back to 4.8%.
Accompanying the Gilt Crash was the margin call crisis for UK pension funds, which Viet Hustler explained in the article:
The comprehensive crisis in Europe.
Explanation of the margin call event for UK pension funds:
The problem of UK pension funds with highly-leveraged portfolios:
Investing in both stocks (risk assets with high interest rates) and UK Treasury bonds (gilts).
Therefore, these pension funds always face the problem underfunded liabilities (when the value of liabilities is greater than the assets at present value on the balance sheet).
Simple example with a US$100 deposit value at a pension fund:
When bond interest rates decrease, these pension funds face the problem underfunded more severely (figure below).
Therefore, UK pension funds use derivative interest rate swap instruments with banks through LDI (Liability Driven Investment) funds to hedge the risk when bond interest rates decrease (to avoid being excessively underfunded on the balance sheet).
However, recently, when Treasury bond interest rates rose sharply in a short period, the value of gilts held by pension funds halved. This directly impacted the value of the balance sheets at pension funds.
Swap contracts between pension funds and banks caused a series of pension funds to face margin calls.
This forced pension funds to sell the bonds they held, further driving down bond values in the market (yields up).
Accordingly, on 10/11, when the BoE announced stopping all market interventions, the BoE also issued an ultimatum to UK pension funds:
Pension funds have 3 days to cover positions after the margin call event.
After that, UK companies are receiving requests to send cash into their pension funds. – According to Financial Times
Liquidity drains: Liquidity collapse in the market
Liquidity is being drained from markets in all major markets around the world, which is a common situation in the global economy, due to tightening monetary policies from central banks.
This is also reflected in the correlation between the stock market and the shrinkage of balance sheets of major central banks at the current time.
CONCLUSION
There are 3 main event lines that Viet Hustler wants to emphasize in this week's summary article:
1. US inflation is still not under control, with items having unprecedented price increase rates. The global inflation trend is rising, and for the first time, the world's average inflation has reached double digits.
2. The energy crisis in Europe continues to escalate while these governments have continuously introduced remedial measures. Meanwhile, the US currently appears less dependent on OPEC+ oil (compared to Europe's dependence on Russia for energy).
3. The UK's Gilt Crash event and the margin call issues of its pension funds have shown the interconnections between the financial credit system and the fiscal and monetary policies of governments and Central Banks.
From these events, Viet Hustler will continue to analyze in depth the sensitive state of the economy, and especially the bond market and banks at the present time, in the second article of this week's Macro Economics section.
Comments (0)
No comments yet
Be the first to comment
Login to comment