What a wild ride this week.
First, we had the spike higher on the headlines that the UK deployed QE to add liquidity to the bond market.
This is an old narrative that the market relied on for the past dozen years. Central bank printing is always a shot of steroids to asset prices.
The Fed will not be far behind the UK in pivoting back to QE, but right now the market is still stuck on Powell fighting inflation …
So, the second move was yesterday after getting strong employment and inflation numbers … SPX gave it all back and more.
Initial unemployment claims came in lower than expected (job strength) and the revision to Q2 GDP inflation was higher. These weighed on and eventually broke the market lower.
However, what is actually breaking is the bond market, specifically the corporate bond market as credit spreads blew out.
Today, we’ll take a closer look at investment grade and high yield-credit spreads and what they mean for the Fed in the weeks ahead.
High Yield Credit Spreads
The Bank of America puts out the high yield credit spread illustrated below. Notice how the spread has broken above the highs we have seen since June ‘22.
We should now go take out the highs at 6% quickly and I think that will be the catalyst for the Fed to pause tightening and then pivoting back to QE shortly thereafter.
I can say this with confidence because what is going on in the UK is very serious.
We are now witnessing what I have been preaching for a year and a half and that is this …
When a country is near the end of their debt cycle, meaning they have printed more money than they are taking in, they risk insolvency.
Now in reality, any country that can print new money in its local currency can always remain solvent. Simply issue more bonds and let the Fed print more money to honor redemptions.
However, the currency that they are printing will just keep losing purchasing power until it is worthless to the consumers holding it.
I have shown this before but it is worth studying hard because the UK has now entered the deficit spending vortex …
The UK, like most countries, is suffering from high inflation and the Bank of England (BOE) is blindly raising rates to try and reduce it.
30-year Rates Skyrocket
In the UK, 30-year rates are the most important because UK pension funds are long 30-year bonds to match-off against their long-term commitments to UK workers.
Now, this has not been an issue while the BOE was able to hold inflation down, but it is a serious problem right now. This is serious because the pension fund liabilities are 120% greater than the country's GDP.
Notice the incredible rise in rates since the start of 2022.
As soon as the pensions were sent margin calls to cover the risk of higher rates, they went to the banks for help …
Now, we all know what happens next …
The banks said sorry we can’t help and then hung up the phone and started selling 30-year bonds, which of course exacerbated the move.
BOE had to come in and pivot back to QE to buy bonds from the market to stop the bleeding.
This is how the UK officially entered the deficit spending vortex.
Who Is Next?
Australia, the Netherlands and Switzerland also have pension funds that have long-term payout commitments that are higher than the country's GDP … Canada and the US are next at 96% of GDP.
Hopefully this gives you a good understanding of the macro flows driving asset prices …
The financial system is breaking and these flows are driving it. The countries in the greatest debt-to-GDP situation must abandon inflation fighting and print money to hold long-term interest rates down.
Bring It Home
The UK has now telegraphed the sovereign debt crisis that is brewing. The UK is having this issue and their bond market is a fraction of the size of the US.
The US bond market is extremely vulnerable to a similar move to the UK, and when US 10-year rates break back above 4% it could ignite massive selling …
Now might not be the time if the Fed at least pulls back from the hawkishness and I think we may be set up for a relief rally next week as we begin Q4.
However, keep this macro picture in your mind because the deficit spending vortex will not subside.
Stay tuned for a special report on exactly how these flows impact the market and in the meantime …
Live and Trade With Passion My Friends …
Griff