The US and the UK are tightly tied together from a policy perspective, so understanding UK problems is extremely helpful for portfolio positioning.

The UK 10-yr bond has dropped an incredible $28 since Aug.1.

The US 10-year, which seemed like it was in free fall, is down $11 over the same period. 

The panic selling going on in the UK has crushed all bonds, the currency and financial assets in general … 

The risk in the UK financial system is the same risk embedded in the US: A greater (and growing) supply of government debt than demand. 

I have been pounding the table on this. When a country whose debt is above GDP spends more than it takes in, it is forced to issue greater amounts of debt.

Investors eventually catch on demand higher and higher rates of interest …

Now, both the US and UK are at levels that present a possible default on government debt – unless the Bank of England (BOE) and the Fed pivot back to QE and purchase excess debt so rates stabilize.

This morning, the BOE pulled the trigger, with this headline …

BANK OF ENGLAND: BANK WILL CARRY OUT TEMPORARY PURCHASES OF LONG-DATED UK GOVERNMENT BONDS FROM 28 SEPTEMBER

Today we’ll take a closer look at the ramifications of the lower prices/higher rates of bonds and a list of stocks to watch for winning trades.

The UK Is Currently the Greatest Source of Instability in the Global Financial Markets

Liz Truss, the newly appointed Prime Minister of England is pushing for a review of the Bank of England’s independence at a time when policy is already under tremendous pressure. 

High inflation, a widening current account deficit and high debt – which is a similar condition the US is in – forced the BOE to surrender the currency (British pound) and go back to QE …

This was done in desperation so they can cap interest rates on bonds and propose spending bills to create economic growth. 

Sound familiar?

It is exactly the path down which the Fed and US government are headed …

In the next couple of months as a deep earnings recession takes hold, you know the administration will start pointing fingers at Jerome Powell and co. for causing the recession.

Then the administration will come to the rescue and spend more money on infrastructure and sending out relief checks.

The Deficit Spending Vortex 

Once a government reaches the point of over 100% debt to GDP it is difficult to grow the economy enough to cover debt payments.

The US reached that point after all the bailouts in 2008.

Next, Covid put our debt to GDP at 130%, and now we are unable to shrink our debt by the normal means of producing greater income. 

We are now stuck in the deficit spending vortex illustrated below. The only solution and next step is to admit we can not control inflation and go back to spending …

What breaks the vortex is when the economy gets so bad that the administration tells the Fed to stop the inflation fight.

With midterms coming, the administration will step in and pass spending bills, which means inflation is reignited.

This is coming and there is no way to avoid it …

But understanding that puts you in a great position to make a killing trading these insane markets.

Prepare Your Watchlist

The shift in the Fed will most likely cause the dollar to peak in the near future as the Fed shifts to QE for the same reason the UK did

Keep an eye on the dollar via the Invesco US Dollar Index ETF (UUP). I purchased the  Oct. 07 31/30 put vertical spreads. You can get a 2.5-1 risk reward, but I will have a tight stop because until the Fed actually pivots, the dollar could continue its uptrend. 

So, think about the flows we have seen as the Fed was tightening to fight inflation in the US market. Basically, the dollar went up and most other sectors went down.

Now if the central bank reverses policy back to printing money, the sectors that should perform the best as investors realize inflation will remain high and the dollar will correct will include:

Gold and silver, possibly Bitcoin, industrials (think infrastructure spend), industrial commodities (copper) and energy.

All stocks may rally in the beginning, but higher inflation ultimately will be bad for financial assets.

So if a stock doesn’t produce or service essential natural resources (food and energy). it will struggle as the global recession deepens.

Bring It Home

I want to share a headline that came across Breaking Market News yesterday …

FINANCIAL INSTITUTIONS ARE BEING ASKED BY REGULATORS TO AVOID TRADING ACTIVITY THAT MAY CREATE LARGE VOLATILITY IN THE SECURITIES MARKET – SOURCES.

Are you kidding me? That tells you there is something broken in the system … I have been saying what it is: the bond market.

Now we have confirmation of the UK bond market imploding because there are not enough buyers for their bonds. 

Here is another one …

Yellen Says Markets Functioning Well, Conditions Not Disorderly — Bloomberg

Meanwhile….

When a policy leader denies a problem exists … it's time to prepare for the problem …

We just had a $57.8 trillion drawdown in US stocks and fixed income market value.

These drawdowns are much greater than even 2008, and the Fed is still tightening …

These facts confirm to me that the Fed will be forced to pull back from any further tightening by its upcoming Nov. 2 meeting.

Stay tuned.

We will learn more in the next couple of days, and as always …

Live and Trade With passion My Friend,

Griff