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Credit Crunch: It's Worse Than 2008...
Welcome back macro heads; we’re going to dive straight in here, a lot to uncover this week. Strap in and as always, lend me your attention. I was raised to give credit where credit is due. It’s only right to give credit to this man here, Jerome Powell for his policy actions throughout 2021 which have led till the current events. Thanks Jay. Jokes aside, we’re in an extremely strained global housing crisis . The way macro conditions are shaping, there is only one way that this situation relieves itself. A housing crash. Financial Conditions: Too Loose, Too Long.. There’s a common saying in markets; Now although Buffett intended this to reference the importance of diversifying your portfolio to ensure one can weather against a downturn in markets; this also applies to the fundamentals which governs an economy’s financial health. Since the GFC, the Global Financial Crisis of 2007, economies around the world have benefitted from a low rate environment, ease of access to credit, full functionality in financial markets through central bank liquidity and rising deficits amongst government bodies. A period many investors call ‘Goldilocks’ within markets and financial conditions; why you may ask? It’s simple, because conditions are just perfect, neither too hot, neither too cold, lukewarm to be exact. Everyone become’s Jim Simmons making huge bets. The type of environment which nurtures steady growth and stable inflation, until you have a year like 2020. I think it’s clear to say we are now in anti-goldilocks within financial markets, where the economy is both too hot in terms of inflation , but also too cold in terms of growth. The below figure shows the a quick-view of how the rest of the world is battling this period of stagflation; a period where inflation is accompanied by low or non existent economic growth. As you guessed, the darker the red/shading, the higher the country’s interest rate. Not a pretty sight I must say. As shown in figure 2, the most recent central bank rate decision for both nations saw an increase with the Fed maintaining it’s hawkish stance against inflation, however, the Uk only able to deliver a 50bps hike due to the severity of the current economy. But what does this actually mean for the average home owner or tenant both in the UK or U.S? Rising Rates, Rising Fears For Housing Market Before we look at the trouble rates are causing within the housing market this chart shows the Bank of England’s official base rate. As aforementioned, rates within the Uk have hovered around 0.5% for the most part of a decade, if not more. Now the period where growth was on the rise within the Uk and inflation was beginning to peak it’s head above 3-4% , would have been a the perfect time for the BoE to test the market’s ability to stomach a smaller rate increase whilst ensuring inflation is within their monetary policy goal. But as we know, the exact opposite happened, they left monetary policy conditions loose, inflation soared above target and stimulus was everywhere to be seen. Figure 4 puts in perspective how elevated home prices are relative to the median income within the Uk. Historically, the Uk house price/ average annual income ratio within the Uk has floated between 4 and 5; except for the Barber Boom and Lawson Boom . Just for some context the Barber boom was named after Uk’s Chancellor Anthony Barber back in the 1970’s, whose budget, designed to return the Conservatives to power, led to a brief period of growth known as “ The Barber Boom ” that unfortunately pushed the economy into a recession. With inflation in the double figures rates had to be increased having a detrimentally negative affect on housing affordability. Some analysts think we’re returning to the 1970’s inflationary period, as we already breached double digits early this year topping 10.1% to be exact. Now the Lawson Boom was also another macroeconomic storm caused by who? You guessed it, the Chancellor of the Uk during Margaret Thatcher’s reign in the 1980’s, seems like Kwasi Kwarteng is only following the footsteps of his predecessor’s in making huge policy changes which force the markets to say otherwise. Simple Put, Nigel Lawson, the man the boom was named after cut the standard income tax rate from 29p to 25p per £1 of income. History lesson over. The ratio between Uk house price and average annual income is sitting at 9, during the 08' housing bubble the ratio was 8.5. What’s worse is that the Bank of England will have to increase rates to keep the fight against inflation going but with rates on mortgages set to be recalculated the bubble I see is a large amount of defaults on mortgage payments. For those on variable mortgages or tracker mortgage, which simply tracks the BoE’s rate changes; things will be getting tighter much quicker. Yields, Credit Spreads & Mortgages in the U.S I hope the picture is clear for you. Rising rates, rising mortgages, defaults, leading to a probable housing crash. Sounds about right to me. Looking at this chart realises the drastic change in credit within the U.S economy. Starting with mortgages, as of today a 30-year fixed rate mortgage would set you back 7% !! It’s the same story all over again but in a different part of the world, markets may not repeat itself but they sure do leave clues. The point to note with bonds, is they both predict future interest rates within an economy and also the underlying risk associated with the issuer defaulting/falling behind on payments; so what we’re seeing today is simply the yield investors are demanding to take on the inherit credit risk associated with the debt instrument and duration. For the private sector, widening credit spreads means only one thing, tougher times. Here’s a reason as to why, as access to credit tightens within an economy, companies looking to borrow funds through new issuance of bonds have to have their credit worthiness tested by global rating agencies such as Moody’s or S&P Global . Now according to the LCR (liquidity coverage ratio), a regulation put in place to prevent banks/large financial institutions from liquidity runs, allowing them to survive a period of significant liquidity stress over a period of a month; they must allocate a specific amount of their portfolio to high grade bonds, upper medium grade and lower medium grade, there’s no room for junk bonds however. The catch is, the lower investment grade the bond is, the less allocation the institution is allowed to make, due to risk levels associated with the investment. So for corporations a simple downgrade from AA- to A+ (S&P rating)significantly decreases the liquidity and capital they can raise as banks/pensions funds/insitution’s have to rethink their portfolio allocation due to the credit worthiness and rating changing. Credit spreads are obviously affected by the degree of borrower’s creditworthiness , but as you can see the regulatory and institutional constraints affecting the decision making progress of huge fixed income buyers play an important role too. So higher rates cause trouble within the private sector when it comes to credit worthiness. Tying this back to more recent events you can see why the Uk is under soo much stress as the credit market faced this hit. Explains the massive amount of selling in gilt markets and the pound as Uk’s debt market was recently downgraded to AA-. A rating that is still high grade but screams to investors “greater risk, I’m going to need a bigger risk premia” - hence why yields are up on every gilt and also why the Bank of England have had to set in to salvage the bond market from tearing apart. Hey guys, thanks for reading! I know it didn’t come out on Tuesday, this was a longer piece so I needed to get it right for you! We’re back on Friday; as always stay tuned and please share, re-post and send to someone Twitter - @JoeOlashugba Instagram - @Joe.olashugba Until next time, Joe
Oct 12, 2022 · 7 min read
The Great Demise: Global Markets
Hi guys, firstly wanted to say a huge thanks to everyone who replied to my request from my article earlier this week - If you didn’t get a chance to send your thoughts do so here: Alright, let’s get into it. Hard To Truss Liz… Over the past week the Uk has been in an absolute frenzy across financial markets. The Bank of England recently stepped in to purchase long dated government bonds , all in hopes to restore order and full functionality in Uk markets after the markets revolted at the Chancellor’s tax cut plans which triggered heavy outflows in capital from the pound and Gilt market. Usually you would blame markets for ‘overreacting’ or just being out of touch with reality. However, this scenario, this was a regrettable mistake from the government. Such that the Tories (Conservatives) have had internal conversations debating whether Liz Truss should remain Prime Minister or if she should be ousted. As it stands the Bank of England have committed to purchasing £65billion worth of UK bonds to sweep out calamity in Uk markets which caused gilts to soar 100bps and sent sterling to $1.03. What’s funny is that the Bank of England was due to start their process of quantitative tightening (QE) by now (1st Oct ‘22) but have been forced to postpone the sale to October 31st. As it stands the BoE’s balance sheet holds £838 billion worth of gilts! Circling back to Liz Truss, after watching markets crumble the PM and Chancellor made a U-turn in policy, admitting their faults in delivering a helping hand to the wealthy. We’ve since seen a recovery of some sort in the pound back to the $1.11 handle. The Uk Is At The Epicentre Of A Crucial Trade-Off Between Inflation & Economic Stability The trade-off between fighting inflation and the damaging consequences of those actions is becoming increasingly visible, especially within the Uk. For those looking at this figure and thinking; 'What on earth is the Uk Government doing?’, you’re not alone. When looking at this, the message to derive is simple, with the planned increase in expenditure (deficit) investors fear the Uk will not be able to manage the increased debt levels which would come at a premium due to the current rate environment; but more importantly the biggest hit comes from investors loss of faith and credibility both within the Uk government and economy as a whole to surface this cycle into the unknown. Just taking a look at Uk Gilts says enough… The question one has to ask is, at what point does the yield on gilts become attractive? Or is the risk/reward profile not worth the investment? Goodbye Oil Longs? When it comes to global growth, there's a few commodities I like to keep my eyes on that tend to signal periods of global expansion and contraction. You may argue there are a few more or something along those lines but these three metals are great indicators of global expansion and contraction within the economy. Even as consumption becomes more digital, we still require commodities to make digital consumption available. A mix of global macroeconomic events have pinned oil prices below the $100 mark and now below the $90 per barrel handle. On going tensions between Russia-Ukraine are causing investors to question their global outlook as supply chains remain constricted, Putin opening the conversation to nuclear weaponry and the explosion of Nord Stream 1 and 2 pipelines. Not only that, but the ever-growing presence of a deep global recession underpins any hopes of a global growth linked commodity rally. As energy prices remain elevated we’re seeing the likes of copper/growth related commodities take a backseat for the remainder of the year. So is the oil long over? Not just yet. Two days ago, Russia and Saudi Arabia announced a 2-million barrels a day cut in oil production. Aim of the game? Prop up oil prices once again after the most recent downward trend for the commodity. Central Banks vs Inflation If we’re being honest, central banks have had their fair share of a beating this year. The constant upward revisions of CPI figures, terminal interest rates and lower growth expectations have led to a difficult path they must travel. Hike until something breaks. That’s it Markets are suggesting the Fed may have to push rates all the way to 4.25% before being forced to cut down to 4.00% to react accordingly to markets. What does this suggest? Much tighter, much longer . That’s the message we’re receiving from nearly all central banks as the global economic picture worsens. The Federal Reserve is making it evident that a hawkish Fed is what we will see until inflation is on a steady decline, the issue is, by the time the inflation figure begins to normalise we would have tipped into a recession. Which means one thing, will the Fed reduce the tightness within the economy or will the Fed keep conditions materially tight throughout the period of weak economic data? It’s hard to say now, as we have seen with the Bank of England there is no telling what any central bank will do. However, there comes a point where you have to let the market be-rid of all excess capital and wealth creation accumulated through the goldilocks period we had from 2020 until now. The ECB are on the same mission, the main concern is that through the raising of interest rates, fragmentation risk also becomes more of a concern. For those who aren’t familiar with this term let me explain: Within the Eurozone, fragmentation risk is the widening of sovereign spreads in some countries within the EU as the monetary policy system leads interest rates higher. The risk here is that as rates across the Eurozone increases, so does the refinancing costs involved with each and every country, even the vulnerable ones like Italy particularly. To factor for this risk investors require a ‘risk premia’ and as this process happens the spreads on such vulnerable countries widens to a point where the goal of progressing monetary policy across the grouped economies within the Eurozone becomes delayed due to uncertainty surrounding the weaker economy’s ability to maintain financial stability. See the below for a better understanding: I will write an in-depth piece looking into the Eurozone economy as the current situation at hand is intriguing to say the least! But for now that’s it. You made it to the end, thanks for reading until now. Always grateful; and as always Share it! Post it! It’s free to do so! Twitter - @JoeOlashugba Instagram - @Joe.olashugba Until next time, Joe
Oct 7, 2022 · 6 min read
Macro Heads, I Need Your Help.
Hey guys, I hope you’re all keeping well and enjoying the volatility & madness going on within markets. I’ve got a nice piece lined up for you coming out this Friday so stay tuned! This mail is a little different, you’ll see. I have a request that requires your help, yes you! As we grow, it is essential to look forward and seek improvement from every angle. That way you, as a part of the MMH community can expand your knowledge of the investment/global macro world in an easy and digestible format. The aim here is to democratise the world of global macro and investing, breaking down the complex jargon and ideologies to laymen’s English where the playing field for us all becomes equal for us to thrive within. What I Need From You. Below there are three simple questions I would love to hear your answers to: Kindly send all answers to the email below, your answers help shape MMH. Why Your Answer Matters Without continuous iteration there can’t be any growth - the only reason you’re here is to grow and stay in tune with macro events; it’s my priority to help push your thoughts and whilst doing so hopefully become a foundational platform for your market insights/understanding. You will see adjustments based on your feedback & more ideas/new initiatives from me moving forward! As always, thanks for your help and the feedback above! any other enquiries/feedback drop an email: email@example.com We’ll be back on Friday for an extensive piece! Stay tuned
Oct 5, 2022 · 2 min read
How The Bank Of Japan Blew Up Capital Markets...
It’s here. In this piece, we uncover: The Power of The BoJ Now, for those of you who may not understand why I would choose to write on this particular central bank; you need to read this. The Bank of Japan single-handedly plays one of the most crucial roles within capital markets globally, and that starts within the bond market. Japan is the single largest holder of U.S debt in the world, holding roughly 17% of all U.S treasury bonds available, now let me put that into context for you. The U.S treasury market is roughly a $11.2 trillion dollar market place; so owning just under 1/5th of that market shows how important the Bank of Japan is to the U.S market. Let’s take it a bit further and expand on how crucial the Bank of Japan is to both the U.S & global asset markets. Up until now, many of you, including me at a point, believed that U.S treasury yields were priced and dictated by the Federal Reserve’s monetary policy stance and major economic data released from the U.S. That’s not the full picture, the world of U.S treasuries revolves not only on U.S economic data and the Fed but on the large holders such as Japan and China who collectively own just under a 1/3 of the treasury market. If the treasury market was only impacted by the Federal Reserve and U.S data, we would have experienced much higher yields within the U.S as inflation took off throughout the year peaking at 9.1% in June. Effectively, what I’m saying is the Bank of Japan has indirectly capped U.S treasury yields through its lose monetary policy program. Here’s why. Yield Curve Control & Low Rates In 2016 the Bank of Japan initiated a policy known as Yield Curve Control , (YCC), this was implemented to keep borrowing costs at all-time lows in order to prop up an inflation-starved economy. If you’re thinking what is yield curve control here’s an explanation: Yield curve control is the process where a central bank of a country aims to control both short-term and long-term policy interest rates. This creates a framework where the central bank can effectively cap borrowing costs regardless of what shape the economy is in, in order to stimulate inflation within the economy. Japan’s Flaw… Inflation has been a massive problem for the central bankers in Japan as factors such as; a low fertility rate, ageing working demographic and due to the expansionary policy of the Bank of Japan, interest rates have been extremely low. Leading to a continuous outflow of capital to the United States and other countries. Private households, pension funds, life insurance companies and many other institutions have bought US government bonds and U.S assets further decreasing the demand for the Yen. Here’s how the Bank of Japan has indirectly capped U.S treasury yields. Through yield curve control the BoJ has capped 10y JGB’s (Japanese Government Bonds) at 0.25%. If JGB yields are pinned at 0.25% then Japanese investors are forced to seek yield overseas by purchasing U.S bonds as one of the only alternatives to realising positive gains on their investments. Through this process of Japanese investors looking overseas, particularly within the U.S for investments, the yield of U.S debt is less influenced by the factors mentioned above but is now simply perceived as a sound store of capital compared to domestic markets in Japan yielding close to nothing. Let’s play the other hand. What would happen if the BoJ were to move away from yield curve control? Absolute chaos, put it this way. U.S treasuries and global yields/credit spreads would be through the roof, cost of capital would be even more elevated meaning the S&P500 and Nasdaq especially would be hammered to the ground. The main reasons are, tech stocks survive off of low borrowing costs and most importantly higher yields mean tech stocks’ earnings in the future are worth less today. Dollar Yen, Pushed To The Limit? It’s safe to say we know the Bank of Japan has got deep pockets, but this depreciation in the Yen must hurt them, right? YTD the Yen has lost close to 25%, as investors have shifted their focus toward the ever-widening interest rate differential between the BoJ and the Fed among other central banks also on the tightening cycle. If you are a central bank or a large financial institution, say a pension fund or asset management firm and you have FX exposure on your books, the last place you would want to hold that would be in a currency like the Yen where your yield is 0.1%. So for the market participants seeing the purchasing power of the Yen slide uncontrollably, you would probably bet on the Bank of Japan being forced to hike rates and abandon YCC, right? Not so easy. Earlier in May this year, hedge funds had bet that the Bank of Japan would be forced to hike rates and even move away from YCC. Take a look at the yellow region highlighted to the right. Traders began shorting JBG’s in hopes that rates would increase causing the price of existing bonds to decline in value. This trade was met with full force as the Bank of Japan purchased a record amount of JGBs in order to defend its yield curve control and monetary policy stance. This trade is heavily referenced as the widow maker because that’s what the BoJ turned those funds into. Of recent, we saw the BoJ intervene to stop the yen slide after the central bank kept its rates low, abiding by its dovish policy; this intervention was the first in 24 years for the bank where the BoJ sold dollars to purchase Yen. The question one has to ask is, how much suffering until the BoJ is forced to pivot? As the only central bank in the world to have rates extremely low, the exchange makes imports of goods costlier for the nation. What a week, thanks for your attention all the way till now! Hope you’ve enjoyed the articles released this week. Always love to hear from you guys; I’ve got some cool things warming up for the MMH community — just give me some time. Share it! Post it! It’s free to do so! Twitter - @JoeOlashugba Instagram - @Joe.olashugba Until next time, Joe
Sep 30, 2022 · 6 min read
Pounded: Did Someone Say Parity?
Alright, before we start I know what you’re going to say. Where’s the piece on the Bank of Japan? The plan was to deliver that piece yesterday but after an eventful Friday evening and start to the week for the pound, something we haven’t seen in over 50 years , I had to make an exception! BoJ piece will be released on Friday, look out for it. Now, back to it: Is It The “Mini-Budget” Or Uk’s Macro Climate? This is the question on most investors’ and traders’ minds. What is the root cause of this crash in the pound? Now, if you’ve been living under a rock the past few days, let me quickly recap what has been going on within the Uk. On Friday 23rd September Kwasi Kwarteng, Britain’s new Chancellor announced his growth plan, which consists of the biggest tax cut in 50 years . The last time the Uk saw a tax cut of such significant size we were in the 1970s inflation period, where the annual inflation rate averaged 12% on a calendar year basis. An inflation figure we will most likely see this fall if economic conditions continue in their current trajectory. Now, the markets’ reaction to this “mini-budget” was nothing short of dreadful. Immediately after the plans were announced there was an immediate withdrawal of capital from the Uk. Earlier this week, the pound touched as low as $1.03 , and gilts also took historical losses as investors weighed away from any assets associated with the Uk; the factor being investors believing that the new growth plan will only add fuel to the inflation fire, which is currently sitting at 9.9% . Not only are investors weighing on the risk of further elevated inflation figures but also the new ‘mini-budget is set to push borrowing to unsustainable levels. Chart 1 shows the market’s verdict on the government’s fiscal plans, and it’s not a positive one at all. During the trading hours on Monday Andrew Bailey, Governor of the Bank of England delivered a statement that many believed was going to be an emergency rate hike to prop up the pound, however, Bailey shut down all bets that we would see an emergency rate hike saying: Feel like I’m watching Jay Powell’s ‘transitory’ speech all over again… Gilts losses, Government Deficits and Quantitative Tightening If you’re still scratching your head trying to figure out whether this destruction in UK markets is because of the mini-budget or the current macro picture let me put your mind to rest. All that has happened since Friday is a massive acceleration in the downwards direction of where the Uk’s economy was already headed. Let me explain. Prior to the mini-budget, the Office for Budget Responsibility (OBR) forecasted that borrowing would be on a steady decline from 2024 onwards; dropping from roughly 84% of national income to just above 80% , a mere 3-4%. After the mini-budget, we can now expect that number to rise an astounding 10% to 94% of national income. Keep the above chart in mind. Now, when looking at data what’s most important isn’t so much the current data point we are seeing, in this case, the yield, it’s the rate of change over a period of time which tells us more about how an economy is shaping up. The chart below will realise this for you. This should set in stone what is happening within the Uk. Just over a month ago, 10y-gilts (government bonds) were yielding just over 2.61% on an annual basis, rewind six months back and you were receiving only 1.68% on an annual basis. Now, 10y-gilts are yielding up to 4.7%! You may be thinking, what effect will this have on the economy? In essence, the realisation that the supply of debt that will have to be sold by the government outweighs the current demand within the market is what has led markets to plunge. This causes investors to flee Uk debt markets and the currency as a whole. Ray Dalio said it best: As it stands sterling has gained some upside pulling back into the $1.07 mark against the dollar; with the current array of factors at hand within the Uk it is hard to see the pound moving any higher than it is right now. Short bets are looming over the currency with hedge funds applying pressure to benefit from the demise. Such an event only makes the dollar even more of an attractive alternative and investment to the pound, equities, crypto/ alt investment. In the past month alone the dollar ETF is up 5.25%! This has more to do with key commodities/assets being priced in dollars, so the repatriation of assets/currency results in dollar demand rather than the actual economic condition of the U.S. At the end of the day, the saying remains, dollar is King! Hey, thanks for reading all the way until the end, I appreciate each one of you guys/girls — we’re experiencing some serious growth within the MMH community so expect some exciting things ahead from me to you! As always, share, subscribe and send me a message so I know your thoughts/feedback, this is our platform. Twitter - @JoeOlashugba Instagram - @Joe.olashugba Until next time, Joe
Sep 28, 2022 · 6 min read