The UK Shot Across the Bow

The third quarter comes to an end with a bang of a week. Today all global rates lower being led by the United Kingdom. Yet, at the same time, European aggregate inflation reached an unprecedented double digits at 10% with a 2% target. In fairness, a great deal of the inflation in Europe and the United Kingdom is outside the control of central banks.?

Eurozone Aggregate Inflation

Today's Chicago PMI Points to Recession. Unlike the prior periods highlighted below, this time around the Fed is raising rates and reducing balance sheet. Core inflation 2.5x target.

Today's Core PCE: Remains sticky and high. Certainly, supports the case from the Fed to continue to tighten into 2023 with today's number higher than expected.

National Association of Home Builders versus 30-Year US Mortgage Rates going back 25-years. A lot of the US inflation is coming from the housing market. A big component of how the Fed manages policy and a contributing force for many aspects of the US economy. Chair Powell was explicit as last week's presser about the need for prices to adjust. Market are adjusting but liquidity in the secondary markets a big concern.

Initial and Continuing Jobless Claims: Very strong week. Still points to a US labor market in good shape. Employment is a lagging indicator, but after a year of transitory inflation, there is little room for the Fed to ignore current data. It is also giving the Fed cover to get rates up should they need to come down when, and if, the employment market turns in 2023.

The USD Strength: One of our favored trades of 2022. It's not all about the Federal Reserve. A global safe haven in a world of declining assets across the globe. And a reflection and lack of confidence in economies abroad as the war with Russia and the Ukraine brings havoc in European and UK economies. Lately, fiscal policies in the UK. In Japan, the lone wolf with the biggest global central bank pivot in decades and still holding onto yield curve control. It may be a welcome transpiration for the Fed domestically, but it carries serious repercussions globally and certainly a part of the issues emanating from the UK pensions this week. And a need for US dollars abroad being seen with the recent TIC data, declining foreign holdings of US Treasuries.

USD, JPY, GBP, and EUR

TIC Data

Liquidity and Financial Stability: We've written since the outset of 2022 the looming issues with market functioning. Time and again, we've seen issues across the globe. Domestically here in the United States with US Treasuries and mortgage-backed securities. It is not even remotely feasible to think we can unwind 15-years of ZIRP and negative rate policy, with a continued buying of sovereign debt, in one year without fallout. For us, living in a world of pure mark-to market for decades, the realism of its impact. A market, structurally, with ZIRP embedded. We witnessed it firsthand this week. It carries clear implications for the Federal Reserve and other central banks around the globe. We hope that this week doesn't set a stage for other central banks to embark on QE while raising rates and running off balance sheet to combat inflation. But this is the structural position central bank policy has created through a number of years. And when it comes to financial stability, the root cause and self-inflicted nature, is secondary. And we lived it this week.

US Treasury Liquidity Index: Back to levels not seen since 2020 when the Fed embarked on ZIRP and the biggest bond buying program in the history of US central bank policy. The Fed will not ignore market functioning. It doesn't mean they will stop raising rates but this is a week that should give them "pause in thought" at a minimal.

On the ground

Markets have boundaries. For me, a lifetime of living within markets. Every pocket over the past 30 years. So many different scenarios, crisis, and risk variables. Seen it all. Never quite seen this. When have you seen a G7 piece of 30-year paper move 100-basis points in one day? When have we seen inflation running 8-10% and central banks buying bonds? While tightening! We are writing the history books in 2022.?

This is the unwinding of far more than the past two years. Over the past decade there has been so much duration and convexity produced globally with zero to negative rates our heads are spinning. It's true. This moment has been brewing for a long time. And it's here. Inflation the catalyst.?

Throughout 2022 we've been highlighting the mark-to market risk with the extremity of these global rate moves. We sensed something was coming without knowing exactly where. Leverage, margin, collateral and boom. It's clear the Bank of England had little choice. And with the BOE still in the hot seat to raise rates, where else can the yield curve go. Much more volatility ahead as the events the past week spillover to other markets. QT to QE in a week.

The BOE didn't pivot: They had no choice. (Apologies, it's temporary until they embark on QT in a few weeks!)

At the medal ceremony this week, clearly the Gilt market gets the gold (spent lots of time around that market and the pension funds). In the end, there's always a catalyst. In a nutshell, although some laud the BOE measures, let's not forget the years of ultra loose central bank policies across the globe. Fiscal too. This is no coincidence.

The catalyst which broke it wide open: inflation. Rates are really?doing nothing wrong. But when the global system gets lulled to sleep with zero and negative rate policy, the risks are there, percolating like a dormant volcano. Extreme moves matter: collateral, margin, leverage: Boy, we've seen this show over and over again across asset classes. Moves like 2022 do not occur without things breaking.?

The BOE had no choice but to save the UK economy. Breaking the ice now for all central banks to say: "we can fight inflation and still buy our debt so long as it's for?"smooth market"?and proper functioning. Brilliant, right?. It's not QE!!! The Fed putting standing repo facilities in place here and for abroad.?Our Fed this year:?

January of 2022,?the Fed on buying assets through March (2022) for?accommodating?"financial conditions and smooth market functioning"

"The Committee decided to continue to reduce the monthly pace of its net asset purchases, bringing them to an end in early March. Beginning in February, the Committee will increase its holdings of Treasury securities by at least $20 billion per month and of agency mortgage?backed securities by at least $10 billion per month.?The Federal Reserve's ongoing purchases and holdings of securities will continue to foster "smooth market functioning and accommodative financial conditions", thereby supporting the flow of credit to households and businesses.?Folks, the first quarter of this year!!!!"

Central banks have no control around policy. It would be great to think the Fed has it right because they've been more forceful. In the United Kingdom, between breathes, QT to QE. Temporary. Look, this is bad. Around the globe. And it's expressing itself in different ways. Risk assets trading higher at one point this week because of what the BOE actions could mean for the Federal Reserve is not a good investment strategy.

The Fed is going to remain committed to the pathway 2022 unless something breaks in the US market. Are they watching issues abroad? 100 percent. Completely bumpy. Could be 100 more, maybe 125 more this year. One thing is for sure; the events of late should give the Fed reason for a?"pause in thought"?at a minimal.?

The Fed wants to get to the mid-to high 4s. That seems to be their resting spot (in theory). With a forecast for core PCE coming down closer to 3% in 2023 it brings real yields across the curve into positive territory (in theory, again). It also moves them toward current spot Core PCE with the intention to see the two cross over. Higher for longer is the consistent theme and tone of the past few months.

As we've been writing, they have cover. All central banks are being forced because of global inflation. Unless something breaks in the US financial markets, or perhaps something abroad becomes systemic, the Fed will continue to move in 2022 and into 2023. And the magnitude of the increases likely to subside as they move closer to a pause.?

Have a great and restful weekend!?