The Day The BOE Blinked

by | Sep 28, 2022

The Bank of England (BOE) blinked last night. 

It pledged to buy as many long-term Gilts (that’s lingo for UK government bonds) as it takes to bail-out the UK pension plan. 

You see, pension liabilities (the present value of all the promises the humble saps who work for them expect to receive in retirement) rise when interest rates fall. The trustees of the plan must have locked in the value of those liabilities with hedges. 

And I bet they did it at their peak when interest rates were at rock bottom low. 

Anyhow, the recent surge in interest rates since inflation took off has reduced the value of those liabilities. This, in essence, made money for the plan. 

Meanwhile, the hedges lost money — as they should. 

So far, so good. 

But…those liabilities don’t throw off cash. They are also as illiquid as you get, so they can’t be sold for cash. The hedges, on the other hand, need cash now to maintain account margins just like you need to add cash when you buy stocks on margin and the price moves against you. 

Well, the plan must have been in a real pickle, for sure. Hence the need for the BOE to buy Gilts, bring down rates, and bail them out. 

And, just like that, you have the first central bank finger to get plugged in the global financial contagion dike. 

When Tailwinds Become Headwinds

The BOE wasn’t standing at the dike alone for long, however. 

Within hours, much of Asia tucked tail behind them with various measures designed to reverse course and return to money printing. China threw in some threats. And Taiwan went with capital controls (more on that in a later post).

So much for the inflation bugaboo, I guess.

Now, everyone and their long-stocks-only dog is — once again — betting /hoping the Federal Reserve will relent alongside their global ideological brothers. The expectation is for them to cease this ridiculous war on inflation post haste and go back to their easy money ways. 

I mean, think about the jobs, right? 

And that’s the “One Big Bet” around which the financial world is currently revolving. 

You either expect the Fed to cease and desist the tightening madness and cure the problem of too much debt with inflation or you don’t. 

I’m personally betting that we’ll get a bit more rally like we saw today (we went long equities for the first time in months in my trading service yesterday).

Then it will head back down. 

That’s partly because I think the Fed will stick it out at least a little longer (or posture as such). But mostly because the recession is as sure to sweep the land as easily as Hurricane Ian passed over the Floridian peninsula. 

It’s not about whether “this is finally the bottom.” It’s about whether we get a 100-to-200-point rally in the S&P before we go down another 1,000 to 1,500. 

Three things lifted the markets over the last 13 years and those three things are now headed in the other direction. 

First, Fed stimulus boosted consumption which boosted corporate earnings and expectations for continued earnings growth. Call this G+. 

The stimulus also lowered interest rates which made G+ even more valuable. Present value of money and all that. 

Call that PV+. 

Meanwhile, inflation fell to historically low levels, which let shareholders get more purchasing power out of the G+ and PV+. Call that I+. 

That’s no longer the case. 

A tightening Fed means no more G+, PV+, or I+. That makes for a pickier investor because the removal of all those plus signs means stocks don’t pencil out until they get much cheaper. 

And that’s assuming nothing else breaks. 

But it will. Perhaps even by the time you read this. 

And the next thing you read from me will be how the Bank of Japan is attempting to solve money’s Unholy Trilemma. Which, if you want to break stuff, is like giving a guitar to a coked-up 80s rock star. 

Take What the Markets Give You

P.S. If you want to follow along as the global financial system implodes, join my FREE Prosperity Pub Community over in Telegram. You will learn ways to make their errors work for you.

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