Hey There Income Hunter,

If you weren’t aware, the UK is now imploding politically and economically.

They decided not to join the EU and Japan in some form of yield curve control (YCC).

For a quick review, YCC is when a central bank prints money to buy its government’s debt from the public markets to push its interest rates down. It’s an ideal tool to use in an inflationary environment when rates are rising sharply. 

That is exactly the situation that many Western governments find themselves in now.

The rates they pay to service their debt is below the tax receipts they receive to cover the interest expenses, so YCC is used to cap interest rates at lower levels. 

The UK enacted YCC last week and then backed out of it and is now going back to a tightening policy.

This flip-flop will have massive ramifications for the markets. It also sets up some great opportunities to profit in the weeks ahead.

Today, we’ll take a look at what to expect and the trades to look for.

UK Balance Sheet Problems 

As a macro trader, you have to look at a government’s balance sheet the same way you would look at a corporation’s.

If a government is taking in less money than it is paying out, eventually insolvency risks will arise.

Notice the chart below showing a turn for the worse in 2022 for the UK current account deficit. 

The event that has caused the UK and EU to get into such a whole is the fact that their energy costs have increased dramatically since the Russian invasion.

Not only did costs for energy rise, but the dollars that they hold in reserve to buy the energy has risen versus the local currency (pound).

Notice the massive USD move higher vs. the British pound throughout 2022 …

As the UK imports oil it must sell its currency to buy dollars and then settle the transaction in dollars …

As the dollar gets stronger each time an energy purchase is settled, they are buying more relative to the value of their local currency. This creates a deficit in their settlement of energy and they must finance that gap by either selling their foreign exchange reserves or printing money. 

Time is Running Out on Reserves

This has turned into a complete disaster for the UK and EU. They have had to use up their FX reserves – only two months-worth remain – to finance this growing deficit.

Both the UK and EU will be out of money by Christmas.

At that point they will have to sell US assets to create the currency to pay for their energy. 

That is the point where the EU and UK crisis becomes a crisis for the USD, as well.

A Sovereign Debt Crisis 

This is what you call an old fashioned sovereign debt crisis.

Now, since all three can print money they will not necessarily go broke … 

However, the only way out is to print money to inflate the currency supply so your investors can continue to redeem their holdings of your debt and you can remain solvent.

This scenario creates tremendous opportunities for trading profits … 

1. Purchase bullish option strategies on energy stocks beyond the midterm elections 

The US has been liquidating its strategic petroleum reserves (SPR) stock to hold energy prices down. Beyond the midterms the supply of oil and natural gas will be constrained and prices could rally significantly. 

2. Buy commodities when the Fed hints at going back to QE to support the US bond market 

Once the UK and EU are forced to sell US bonds to finance their energy purchases, the Fed will be forced to go back to printing money to maintain liquidity in the most important market in the world … the US Treasury market.

The pivot back to printing money will be massively bullish for commodities … 

Here is a chart showing this battle between Treasury bonds and oil. It must resolve itself soon or the financial system will break. Resolution will be the central bailing on tightening policies to support their debt markets …

Bring It Home

These are historic times, which require historic moves that markets have been through before – even if each time presents a little twist.

As I always say, trading is a numbers game. Currently, the shift in the supply-demand imbalances of energy and debt are creating an incredibly volatile situation.

Control of these markets by Western central banks is coming to an end, and that is why the trading opportunities are so great …

The OPEC decision to cut oil supply and the UK decision to tighten further are events that will push the imbalances to their limits.

Stay tuned for more in the days and weeks ahead and as always …

Live and Trade With Passion My Friend …

Grif