The Bank of England spooked markets on Tuesday. Watch for the dollar to get even stronger as all of Europe continues to deteriorate and starts to look like a 1990s emerging market travesty.
Bank of England Governor Andrew Bailey told pension fund managers to finish rebalancing their positions by Friday, October 14. That’s when the central bank is due to end its support program for the local bond market.
“We have announced that we will be out by the end of this week. We think the rebalancing must be done,” Bailey said at an event organized by the Institute of International Finance in Washington on Tuesday. “My message to the funds involved and all the firms involved managing those funds: You’ve got three days left now. You’ve got to get this done,” Reuters reported him saying.
Also on Tuesday, pension funds were reportedly selling local securities to raise cash to shore up losses before the central bank leaves the market. If the market tanks on Wednesday, it is reasonable to conclude that the BoE will revisit this “three-day” deadline.
“My immediate reading for the market tomorrow is that Bailey wants the Bank of England out of the business of bailing out pension funds,” says Vladimir Signorelli, head of Bretton Woods Research. “This says to me that means they don’t want to be buying bonds to relieve stress for these funds. It’s kind of trite to say something is going to break in Europe, but look at all these populist demonstrations telling the leaders of Europe to get energy prices down and let these economies grow. The opposite is true. Europe is being set up to be put back into the dark ages.”
The BoE began its emergency intervention on September 28 after a sell-off in long-dated U.K. government bonds threatened to collapse multiple liability driven investment (LDI) funds, held by U.K. pension schemes. These are derivatives, not actual investments in a company’s debt, a nation’s debt, or equity. These are hedge plays, overall.
U.K. gilt prices are likely to fall, with yields rising, as investors bail on this increasingly sad sack market.
The S&P 500 closed lower on Tuesday but rose in the after-market hours as central banks started selling positions to hold cash in dollars and buy U.S. Treasury bonds. U.S. growth stocks, led by the Nasdaq, continue to underperform.
Stronger Dollar (Almost) Guaranteed
There are a lot of moving parts in a global market, but a stronger dollar is almost guaranteed at this point.
The U.S. dollar index is trading at 113. The last time it was that high was in 2002 during the war in Iraq.
The surging dollar is bad for emerging markets with dollar debt.
“A widening debt crisis in (emerging) economies would weigh heavily on global growth and could precipitate a global recession. U.S. dollar strength can only compound the likelihood of debt distress,” the International Monetary Fund said on Tuesday.
This depends on the country. The Brazilian real is doing well against the dollar. The British pound and euro are weakening against the dollar. A strong dollar is good for importers in the U.S., but bad for exporters like Boeing
The dollar’s gains against core currencies is “exacerbating the stress in financial markets,” says Ruchir Sharma, a former Morgan Stanley
Sharma does not mince words in his October 10 op-ed in the Financial Times, saying, “the dollar has become a wrecking ball, rising far higher than one would expect based on fundamentals, including the gap between interest rates in the U.S. and the rest of the world. Its extraordinary spike is driven by investors who think the dollar is the only haven and speculators betting that it will keep rising.”
The dollar has become the only game in town.
With Greta Thunberg being rolled out by political insiders to convince German urbanites of the need for nuclear, Brits turning to candle light to save on electric bills, and the French dimming the lights on the iconic Eiffel Tower last month to ration energy, Europe is looking like a politically risky emerging market, only one without a growth story.
“Bailey dropped a bomb on the whole market,” says Brian McCarthy, head of Macrolens. “The markets tolerance for uncertainty is already low, so that was unnecessary,” he says. British pension funds already knew they had until Friday to unwind, or figure something out about those hedges.
“Would I buy Europe right now? No, unfortunately, you can’t touch it,” McCarthy says. “Europe faces the same problems as us with inflation and interest rate hikes. Only they’re all sitting on a much more volatile powder keg.”
Vanguard’s FTSE Europe (
JP Morgan CEO Jamie Dimon warned the S&P 500 could fall another 20% before all of this is over. A recession again next year is guaranteed. All of this ends when the central banks say inflation is under control. At roughly 9% in the Western world, with interest rates still half that, the central banks of Europe and the U.S. are willing to slow demand to kill inflation rather than increase supply to lower prices.
The only consolation prize for U.S. investors is that we are not Europe.
Over the last five years, investments in VGK moved in line with EEM while the S&P 500 has gained over 40%, thanks mainly to monetary stimulus and foreign inflows into U.S. securities, pushing up the dollar’s value.