Macro micro trader

Bank of Japan announced last week it would intervene in the FX market to stop free fall of the Yen. Market has been punishing the Yen as being the only currency for a country where interest rates are still at zero and the country still grapples with deflation in a world facing inflationary pressures. The BOJ has been controlling the yield curve to ensure the money flows into the economy to generate inflation (if you do not know what a yield curve is, feel free to ask). I have always wondered how could you generate inflation by artificially controlling the markets? When the whole world is reeling under inflation and your currency is in a free fall, there is all the more reason for the markets to be free and let the imported inflation drive prices up as against controlling it artificially. But I guess Japan will always remain a mystery for the world forever. (Yes, I’m aware of their demographic situation, yet I don’t buy that argument in the current economic backdrop).

Then came today’s Bank of England announcement to inject £65billion into the long term gilt market (gilts are the UK govt bonds) to stabilise ever surging bond yields. I would call it a Lehman moment averted for the UK. For now. But why did the BOE has to do that?

When complacency seeps in, you assume things would always remain normal in the economy (whoever coined ceteris paribus in economics!). We also never learn from others’ mistakes assuming what happened with others, would never happen with us. While the world knows why 2007-08 GFC happened (too much leverage), the UK seems to have learned nothing from those lessons and continued to allow leveraged, complex derivative positions into the pension markets. The end result – when the newly formed Truss govt announced its populist budget last Friday, bonds collapsed (yields rose), the Pound wallowed. In the next three days leading upto today, hedge fund and pensions funds ran into margin calls. What do you do when you’re neck depth in collateral and you get a margin call? Almost entire pension fund industry in the UK ($3.59 trillion as of 2020), runs on leverage and when you get margin call for even a 10% for those, you have a situation that can turn the economy upside down.

What the BOE did was only what any other central bank would do in a situation like this. But is BOE the really responsible for what happened? Yes and no. Yes because it allowed the leverage of this magnitude and no because it was triggered by the Truss govt’s ultra lose budget.

Now the bigger question! Has it done right by injecting the liquidity into the system and are we nearing a time when all the other CBs would pivot too? Firstly, what BOE has sone is pushed the crisis just a bit further. While immediate collapse has been avoided, inflation would only exacerbate further in an economy that’s reeling with CPI inflation as high as 10%! The crisis for now has only been postponed, but the real crisis – inflation has only magnified. Not just the BOE, but the UK govt’s budget has done no good to tackle inflation. You need austere measures to tackle inflation, not loose fisc.

Chances are some other central bank might follow suit when a situation like this arises in some other country, but the global inflationary problems would become far more entrenched and growth far more scarce in such a scenario.

I am all the more worried of what world are we going to live in if the govts and CBs don’t mend their ways now? I’m all the more certain now of stagflationary scenario staring at us in the near future and we would have nowhere to hide!