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Getting the gilts screw up right

This is really what happened:

I have long called myself “the Clearing Cassandra” for my repeated and unheeded warnings about the dangers of letting the Trojan Horse of clearing (and the margining of uncleared trades) into the financial citadel. Specifically, clearing/margining can create financial shocks (and indeed financial crises) rather than preventing them (which is the supposed justification for mandating them).

We have seen several examples of this in the past several years, including the COVID (lockdown) shock of March 2020 (a subject of a JACF article of mine) and the recent energy market tremors. The most recent example, and in many ways the most telling one, is the recent instability in the UK that led the Bank of England to intervene to prevent a full-on crisis. The tumult fed a spike in UK government yields and contributed to a plunge in the Pound.

The importance being that if we misdiagnose the problem then we’re never going to find the right answer, are we?

30 thoughts on “Getting the gilts screw up right”

  1. The issue isn’t clearing itself, it’s the EU-derived MIFID requirements for clearing in cash. Had DB schemes been able to post government bonds as margin/collateral (even with a suitable haircut) then this would have largely mitigated the situation.

  2. From the article:
    “The LDI strategies were right way risks. Interest rate movements that cause swaps to lose value also increase the value of the funds (by reducing the PV of their liabilities). The funds were not–and are not-leveraged plays on interest rate risk. So the prospects of defaults on derivatives that could be mitigated by clearing were minimal.”

    Thats a bit like say the ‘Win at roulette by betting on black and doubling your stake each time until you win’ strategy is a good one. It is, if you have infinite cash. There’s plenty of companies that ran out of cash before their assets were less than their liabilities. Yet they all go bankrupt the same. Ask Northern Rock.

    Of course there was an interest rate risk to the LDI strategy. If interest rates went up, the pension fund needed cash, lots of it, to post collateral. Which they didn’t have. Ergo they were hoping that interest rates rises wouldn’t result in more collateral demands than the amount of cash they had available. Through the twenty teens that was a reasonable bet. At any point after the entire Western world splurged trillions of printed money into their economies to combat the sniffles it became untenable – it was obvious rates were going to rise to combat rapidly rising inflation. The pension funds had more than enough time to avoid this car crash, yet they did nothing.

  3. Jim – so the gilts panic had nothing to do with Kwasi Kwarteng’s modest tax-cutting budget, it was created by the Bank of England and then weaponised to justify the coup?

  4. If pension funds are mandated by the regulator (aka Gordon Brown, effectively) to be long gilts at some level, the market liquidity (the free float) is artificially lower.

    The amount of “extra” volume hitting the market that is needed to move prices/spreads would also be lower, so volatility would increase (be higher) than otherwise once the BoE decided to increase rates.

    In the market, once prices start moving, no-one actually knows who the sellers are until some period of time afterwards. A buyer might not know who the seller was even after the trade has settled.

    Is it Andrew Again who does this stuff for a living?

    The question would be how long would it be before some number of pension funds are able to unwind the LDI positions and escape the management contracts given the interest/inflation rate environment has changed?

  5. “so the gilts panic had nothing to do with Kwasi Kwarteng’s modest tax-cutting budget, it was created by the Bank of England and then weaponised to justify the coup?”

    Yes and no. The Kwarteng budget (including the borrowing for the energy price cap) was the straw that broke the camels back. All the previous borrowing for Covid etc had been monetised by the BoE so the markets were sanguine about that, they know (as everyone bar our host does) that the covid billions will never be extracted from the economy. QT will never happen. But now they faced far less borrowing than for covid but without the BoE doing the heavy lifting, and potentially starting QT up in November as well. Cue rates beginning to rise. Which in turn created the pensions fiasco (which situation had been studiously ignored by all the highly paid people tasked with monitoring exactly such systemic risk type behaviour).

    I don’t agree the BoE created the crisis, but I do think they weaponised it to destroy Truss and Co for sure. By creating a end date for their pension fund support scheme, and then just a few days prior to that date confirming it in no uncertain terms: ‘Get it while its good boys, Fridays the last day!’ they told the markets ‘We are letting Truss and Co swing in the wind’. It was Bailey’s speech in Washington that precipitated Kwarteng being dragged home to be sacked and Truss given house arrest by the usual WEF mob.

  6. . . . the markets were sanguine about that, they know (as everyone bar our host does) that the covid billions will never be extracted from the economy. QT will never happen. But now they faced far less borrowing than for covid but without the BoE doing the heavy lifting, and potentially starting QT up in November as well.

    Do they know or do they not?

  7. Tim

    You’re missing out on some beauties I fear.

    Why should the people of the UK have to accept catastrophic mortgage and rent increases to fight inflation that has all its sources outside the UK, meaning their sacrifice will be in vain? The policy looks like that of a WW1 General, it’s so sacrificially foolhardy

    Apparently we need to ‘go it alone’ – I thought Brexit was a bad idea – this guy is channeling Erdogan in Turkey or even the ultimate ‘Curajus State’ leader, Kim Jong un himself…

    The economic crisis we face in the UK is not the result of the price of labour being too high. We have a crisis because the price we pay to occupy land is too high and the price we’re going to be forced to pay to use money is too high. So why is all the focus on cutting wages?

    I think Labour shortages are being reported across every industry I know of. Wage price increases have been high across many of them. Additionally many of them have had two years nearly on full pay doing nothing (Especially in the public sector)- best not mention that of course.

    Assumptions for an economic policy

    – If the world is going to inflate prices we will too, inevitably
    – So we need to protect people from them
    – That requires inflation matching pay rises
    – And it means prices we can control, like interest rates, are kept low

    Tell me why not?

    This guy teaches economics in a UK university (Apparently) I’d be genuinely interested in finding out the employment rates of that course’s graduates.

    It’s a veritable feast of gems I tell you!!

  8. Jim & Steve – Andrew Bailey commenting on his meeting with Jeremy Hunt and talking of their being “of one mind” was a bit of a give away.

  9. “Do they know or do they not?”

    They know now, the BoE blinked. Their bluff was called. It was never going to happen, and even what was on the cards was ludicrously small. According to the BoE time table they would have unwound just the covid QE by about 2030. The rest would have taken until about 2050. Great for inflation in 2022.

    BoE today announced the ‘delay’ of its QT programme:

    https://www.ft.com/content/92a0de1a-a710-4460-8bb1-a98cb9932995

    Anyone want to take bets on when they might think about starting it again? This year, next year, sometime, never?

  10. So, in summary, it was unwise of the politicos to brief that Bailey is a useless tosser who ought to be sacked before actually sacking him? Sounds plausible.

    But I still wonder whether an anti-Brexit quisling coup is going on. In other words, I wonder about the difference between a cause and a pretext.

    I was opposed to the principle of the capping of fuel costs but assumed that it was about the only useful thing that could be introduced in time for winter. I can see that if that were the motive there was no need to make it a two-year deal because six months would surely have been ample to allow the design of a less damaging policy. To that extent I don’t cavil at Hunt deciding to end it w.e.f. April. (Aside: by golly I don’t like the cut of Hunt’s jib.)

    I suppose that as each domino falls we’ll see how little of the debacle is peculiar to the UK, how much is about the whole of Western Civilisation being in the merde. We may soon have a vacancy for PM whereas the US already has a Vacancy as President.

    Lastly it is irresistible to point out “I told you so you fucking fools”: like many others in this comments club I thought the lockdowns sheer bloody madness. I was also no fan of a dozen years of free money. Woe, woe, and thrice woe.

  11. And then there’s the shoot-ourselves-in-the-foot sanctions on Russia. The list goes on and on. Net Zero, …

  12. To that extent I don’t cavil at Hunt deciding to end it w.e.f. April.

    That may also have had something to do with European gas prices dropping considerably. Hopefully that trend will continue but I wouldn’t bet the farm on it.

  13. I suppose that as each domino falls we’ll see how little of the debacle is peculiar to the UK, how much is about the whole of Western Civilisation being in the merde

    Crazy shit going on in France, apparently. The French are revolting. But they’re also protesting their own government.

    European gas prices dropping considerably. Hopefully that trend will continue but I wouldn’t bet the farm on it.

    Indeed not, until the fundamental underlying problem of supply is resolved prices will probably continue on their crazy rollercoaster ride, but likely always be too expensive to be compatible with the sort of living standards Brits and Euros have come to expect as their birthright. There’s no evidence the UK or Europe are even beginning to tackle the problem.

    Unfortunately I don’t believe Mr Hunt cancelled the energy price guarantee because he’s expecting good news. I reckon that’s our Net Zero here already, and they’re going to hunker down while the British middle class evaporates in the heat of permanent price hikes.

  14. “That may also have had something to do with European gas prices dropping considerably.”

    Does anyone else hear echos of the covid lockdowns when looking at the gas price chart? There appears to have been an explosive blowoff in prices and then a massive slump precisely at the point Western governments had agreed to borrow hundreds of billions to protect their populations from freezing to death in winter. If they had waited a few weeks they could have got away without it. But then if they’d waited would the prices have dropped? Rather like the way governments were pressured into pointless (and damaging) lockdowns at the very point the curve was turning, have they been similarly done over here? Are nefarious forces at work? Or is it just that our 24/7 information world cannot deal with ‘Well lets just wait and see what happens before making a stupid mistake’?

  15. Dearieme

    Like Longrider and many others I opposed the lockdowns and consider them one of, if not the greatest, crime in human history. Utterly outrageous and completely unjustified. I take scant comfort in being proven right. I note with alarm the PHA under which they were introduced remains unchanged and hear the siren voices (Like Murphy) calling for potential Climate Change lockdowns.

    Steve

    I hear the weather is good in Yekaterinburg…

    Crazy shit going on in France, apparently. The French are revolting. But they’re also protesting their own government.

    Isn’t that the painful truth…

    Indeed not, until the fundamental underlying problem of supply is resolved prices will probably continue on their crazy rollercoaster ride, but likely always be too expensive to be compatible with the sort of living standards Brits and Euros have come to expect as their birthright. There’s no evidence the UK or Europe are even beginning to tackle the problem.

    I still see the hand of the WEF and other organizations here – we need to consume less. That’s the underlying message you get across all forms of MSM and social media.

    Unfortunately I don’t believe Mr Hunt cancelled the energy price guarantee because he’s expecting good news. I reckon that’s our Net Zero here already, and they’re going to hunker down while the British middle class evaporates in the heat of permanent price hikes.

    Spot on – but at least we’re ‘winning the war in Ukraine’ right?

  16. Bloke in North Dorset

    As Maggie might have said: There is no such thing as The Market, only men and women trying to make money.

    The problem is that when whatever the so called Libertarian equivalent of Teenage Trots is decided they didn’t need to consult anyone, not even their own cabinet, about a major fiscal event all those people did a WTF and moved to protect themselves. Not necessarily because of any or all all of the tax changes but because there was a risk of them doing something really stupid without being checked and those people don’t like uncertainty.

    If Truss and Kwarteng had included their cabinet and the OBR in their plans they might have got away with it, well not the top rate tax reduction, but they’d have been told in no uncertain terms how politically stupid that was. Even if the OBR had given different figures to them they’d have been able to make their case and would have been hear.

    But Truss has shown the intellectual abilities of Dianne Abbott when it comes to explaining policy so know were stuck back in the ’70s.

  17. BiND – I’d be careful about about the OBR. Take a look at when it was introduced, and compare it to the European SGP.

    Short answer – fuck the OBR.

  18. If they had waited a few weeks they could have got away without it. But then if they’d waited would the prices have dropped?

    Steady on, you’re in danger of cheering me up a little. If National Grid was selling our gas on to Europe when the price was peak, and is now buying gas for us when it’s much cheaper . . .

    . . . nah, they can’t be that smart, can they?

    By the way, overall European gas reserves are now at 92% and Germany is at 96% – and Jerry has listened to Greta and is keeping all three remaining Nukes online until at least April next year. Spain is having to turn away LNG shipments due to unload capacity, so there might be some more of that floating about.

    While looking at this stuff I just noticed that UK electricity prices are up 42% year-on-year. That’s a lot but nowhere near Germany’s 180% and France’s 297%.

  19. Thinking about it KK’s budget was just bad politics. If he had cut from both ends ie not a penny off the basic rate, but significantly increased the allowance, he might have got away with it.

    I ought to say that I take no pleasure in being right about the effects of NetZero, Lockdowns, Vaxxes and that the “elites” were not going to allow Brexit nor Liz’s premiership to go ahead.

    But I fucking do ! I hope this whole confluence of shitshows opens some eyes.

    I think I might go and live somewhere relatively well run… Like Hungary… or better still, Zimbabwe

  20. Are nefarious forces at work?

    Obviously yes, they bombed Europe’s main gas pipeline and want us to rejoin the EU.

    As for gas prices, there’s huge fluctuations, but they’re huge fluctuations at eye-wateringly expensive prices:

    Average wholesale gas prices in Q3 were 115% higher than in the previous quarter, 18% higher than the previous record-breaking average gas prices of Q1 2022, and more than double those seen in Q3 2021.

    nah, they can’t be that smart, can they?

    If they were smart, they wouldn’t be currently telling the FT about their plans to shut off your electricity between 4pm and 7pm on winter evenings.

    Spain is having to turn away LNG shipments due to unload capacity, so there might be some more of that floating about.

    Yes, but that’s the problem. There’s not enough unload capacity in Europe. It’s a serious bottleneck that’ll take years to fix, and LNG is also very expensive. Too expensive to save the German economy, for example.

    overall European gas reserves are now at 92% and Germany is at 96%

    Idk why so few people have asked the question how long the reserves will last (it’s about 10 weeks, btw).

    The only way out of a supply crisis is to get more supply. We need to get fracking, 10 years ago. But we won’t, that’s as dead as Liz Truss’ authority. Though I was reading about how the Conservative government’s “food tsar” is recommending that the proles should eat insects like the disgusting ghouls he thinks you are.

    So there’s that.

    That’s a lot but nowhere near Germany’s 180% and France’s 297%

    This is one of the craziest things. France and Germany are utterly fucked. It’s unbelievably bad over there, and it’s going to get so much worse. Our problems are very serious, theirs are critical.

    Most Brits have absolutely no idea what’s going on in Europe, they’re deliberately being kept in the dark (hey, we might as well get used to it) and given the vague impression that Britain is worse off (because of Brexshit :smirk:).

  21. Bloke in North Dorset

    Ducky,

    I wasn’t defending the OBR, a pointless exercise, but as it’s become part of the process not using it added to the sense that Truss and Kwarteng didn’t know what they were doing and something to hide.

  22. . . . they bombed Europe’s main gas pipeline . . .

    It’s amusing that the limited imagery released so far shows the pipe metal bent outwards. Fifty metres of pipeline supposedly missing implies a very thorough sabotage effort, yet one of the four pipelines is still there and technically functional. It’s all very odd.

    If they were smart, they wouldn’t be currently telling the FT about their plans to shut off your electricity between 4pm and 7pm on winter evenings.

    Indeed, but scary stories about shut-offs are not shut-offs. It might be smart to persuade people to conserve.

    Idk why so few people have asked the question how long the reserves will last (it’s about 10 weeks, btw).

    Most people understand that reserves aren’t the same as supply. Two and a half months of reserve to cover intermittent shortages over a four month winter is a pretty good buffer. It represents more than the 40% reduction from a total loss of Russian supply.

  23. BiND – oh, fair enough.

    The thing is, BoE independence obviously meant that monetary policy was no longer under the control of elected politicians (subject to vagaries in the amount of control they might have actually been able to exert anyway). That left politicians with regulatory or structural control, and fiscal.

    However, they were able retain control over the target – inflation – as measured by RPI, or RPIX or CPI, CPIH. And the level. Oddly, the level was curiously similar across a range of developed economies, and the target measure used was homogenised.

    There appears to have been a very common assumption as to what the cause of inflation actually was, either and only some combination of domestic money printing, or wage demands.

    The creation of ESG and the OBR removes or severely limits the fiscal control element, leaving only regulatory or structural control.

    Since deficits generally ballooned out following the GFC, then the Eurozone crisis and finally Covid, the BoE has effectively just assumed control of fiscal policy. Most likely the same will/has occurred within the Eurozone, plus those polities most tightly coupled to it.

    It then turns out that the assumptions about the causes of inflation were wrong…

  24. PJF – I admire your optimism (honestly), but from everything I’ve seen over the past two and a half years, it’s evil clowns all the way down.

    It took a special degree of cuntwattishness to bring Britain, a country bursting with coal, oil and gas, one of the first countries in the world to develop atomic energy, to the point where we’re seriously discussing blackouts and £6,000 leccy bills. As if this was some shithole banana republic in Africa, when that’s only partially the case.

    You seem to be hoping they won’t have more genius brainwaves to come. I know that they do.

    Ducky – the BoE has effectively just assumed control of fiscal policy.

    Of course they have. It’s a mirror image of the similarly “independent” Supreme Court. (That’s another mess the Tories won’t be fixing, eh?)

    Blair’s genius was in taking vast swathes of money and power out of the hands of elected politicians (because let’s face it, you can’t trust voters) and into the hands of, well, people like Tony. Permanently. That’s another reason why they’re still furious at us over Brexit.

    Basically, all those loonies who were raving about the Trilateral Commission or whatever were correct. It’s hard to think of any major Western country where the public aren’t routinely shat on by their own rulers and where, for some reason, the majority never gets the policies it wants from its own political institutions. The facade of democracy has been rubbed bald.

  25. The Cassandra this Cassandric that bit isn’t about ‘seeing the future’. It’s about ‘thinking emotionally’ and testing the waters for a mtf transition from Richie to Cassandra.

    That will show Tim. All those Ragging on Ritchie tags will be nothing more than rude deadnaming. He will have to thunk up a new take. ‘Criticizing Cassandra’? Not clever enough. Tim will have to work for his alliteration!

  26. “While looking at this stuff I just noticed that UK electricity prices are up 42% year-on-year. That’s a lot but nowhere near Germany’s 180% and France’s 297%.”

    But aren’t UK prices currently capped? Not only by OFGEM but also now subsidised by the taxpayer? What would the % rise have been if we’d had to go onto a free market floating rate, rather than the subsidised and capped rate we have currently?

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