London financial turmoil may head for Wall Street

Commentary

British government bonds, so-calledsow,The UK equivalent of the U.S. Treasury Department is financed by Treasury Secretary Kwasi Kwarten. £30-40 billion Last Friday’s tax cut. The supply-side tax cut aims to bring the UK back to 2.5% annual growth.

But without corresponding cuts to government services, especially the exorbitantly costly National Health Service, cuts will drive the UK public finances further into debt. The market saw not only inflation but also rising debt and responded by demanding higher interest rates. This has been influenced by the market depreciating gold coins.

British sow prices took a hit from the market in the early hours of Wednesday ET. British pension funds, which had presented portfolios of gold coins as collateral for borrowing capital to boost returns, suffered margin calls as the value of their bonds fell along with the value of the British pound.

The Bank of England (BOE) intervened by committing to buy long-term gold mines “with a residual value of 20 years or more” to stabilize the market and “restore orderly market conditions” (e.g. , a 30-year gold mine sold in 2013 has a maturity of 2043 and a residual value of over 20 years).of BOE said“The purchase will be executed on the scale necessary to bring about this result.”

BOE’s intervention has stopped bleeding in UK sows, at least for now. However, it raises serious concerns about market stability. Mainly in the UK, but also around the world.

and attached at the end is BOE statement This morning, this tag was embedded at the bottom of the release (MPC is the Monetary Policy Council, similar to the Federal Reserve Board).

“The MPC’s annual target of £80bn of inventory reduction remains unaffected and unchanged. The first gold leaf sale will take place on October 31st and will continue thereafter.”

In other words, the BOE was backing out of its planned balance sheet reduction. This reduction does not resemble the planned reduction of the balance sheet of the US Federal Reserve.

need to be careful

While the pound is still a valuable currency, it is important to note that it lost its status as a global reserve currency when it was replaced by the US dollar decades ago. The fact that the pound is less important than the dollar these days means that the pound has become more vulnerable to the whims of the global sovereign debt markets. Pounds when payment is made. (For example, the Japanese yen, which was about the same as the dollar 30 years ago, is now worth ¥145 to the dollar, as the debt-to-GDP ratio has soared to more than 2.5 to 1.) Pound has similarly fallen relative to the current “King Dollar”.

The UK debt to GDP ratio is currently 85 percent of Gross Domestic Product (GDP). However, it is no longer the world reserve currency it was in the first half of the last century. The UK economy is much smaller than that of the US, China or the European Union. Less demand obviously means less value and more risk to lenders.

On the other hand, the US dollar’s status as the world’s reserve currency was once dubbed an “exorbitant privilege”, which means that lending nations are forced to maintain a much larger balance of payments deficit than the United States would otherwise. It means that it is possible to

For illustration, let’s assume a simple bilateral case.

Country X sells its goods or services to country Y in exchange for the currency of country Y. Since country X cannot use country Y’s currency, country X uses the won country Y’s currency to do one of three things: 1) Buy Y’s exports. 2) buy Y’s assets (factories, land, stocks, etc.); or 3) buy Y’s government bonds. So if country X has a current account deficit, that is, if country X buys from his country Y more than it sells to his can buy Y’s assets or Y’s government bonds.

Country X is functionally equivalent to China and Country Y is functionally equivalent to the United States. Because of the US balance of payments deficit, China (and several other trading partners) have excess dollars, all of which need to be returned to the US. After China purchases US goods and services, the surplus funds will be invested in US assets such as real estate, stocks and US Treasuries. This will allow the US to finance her $31 trillion national debt.

But the dollar’s “exorbitant privilege” under this scheme could be at risk.

US Debt to GDP Ratio, 1940-2022

In 1981, when President Ronald Reagan pushed for supply-side tax cuts and passed the Recovery Tax Act to stimulate a lazy US economy (as Prime Minister Kwarten has planned for Britain), the US debt The ratio to GDP has reverted back to about 31% then. The ratio now stands at 123% of his GDP, higher than it was during World War II. While this ratio has fallen somewhat as GDP has increased since the pandemic, it is still exorbitant and calls into question lenders.30 years? Lenders who think “not much” are more likely to demand higher interest rates, further reducing the bond’s value.

30-Year Fixed Maturity US Treasury Market Yield
(Investment basis, 9/17–9/22)

The US could therefore face the same kind of liquidity crisis that the UK faced this morning.

The Federal Reserve, like the BOE, is tightening credit with higher interest rates while allowing its balance sheet of US Treasuries and mortgage-backed securities to burn up to $95 billion per month. Therefore, bond values ​​are declining and, as a result, bond yields are rising. As shown above, the 30-year Treasury yield surged to its highest rate since November 2018. Yields on 30-year Treasury bonds briefly hit 4% on Wednesday before rates fell and the market recovered from its slump to close 1.8% higher.

The BOE postponed Wednesday’s planned gold coin sale until the end of next month, as markets seemed to believe the Federal Reserve would ease market tightening. If the Fed loosens monetary tightening to avoid or avoid a recession, it should plague markets rather than stimulate them. This means the Fed has effectively lost control of monetary policy.

In summary, global markets are clearly volatile. There is a risk of a liquidity crisis in the US, but this is unlike what the UK briefly experienced on Wednesday, when a margin call on bond collateral forced a sell-off and pushed interest rates higher. There is a risk of triggering a sharp downward spiral in prices, pushing interest rates higher. It can be a very dangerous and volatile time.

Investors should act with caution. Start by rebalancing your portfolio towards cash and place a stop loss order on your brokerage account.

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