Thank the Lord for the Bank of England!

Blain’s Morning Porridge, September 29th 2022: Thank the Lord for the Bank of England!

“Who needs asteroid busting satellites when you’ve got the Bank of England”

This morning – The Bank of England averted a run on the UK’s investment institutions yesterday. Chancellor Kwarteng is unlikely to thank them for their calm competency and credibility. The Bank’s intervention has triggered a global rally as the market now expects more central bank support.

Relax. There is nothing to worry about. We are as safe as The Bank of England. (Which, incidentally, was founded by a Scotsman.) When the going gets tough, Central Banks will be there to resolve it, putting sticking plasters on our financial wounds. Yesterday The Bank acted swiftly and with demonstrable competency to avoid a technical issue in the UK Pensions Industry triggering a systemic financial failure. The market took note – Central Banks will act to avert meltdown. Hence yesterday’s Global rally.

The UK may be a small island at the unfashionable end of Europe, but we still set financial fashions and influence global markets – unfortunately for all the wrong reasons. Yesterday’s £65 bln re-opening of the QE programme to buy Long Dated Gilts (a time limited window which has a high likelihood of success) unravelled The Bank’s plans announced just last week to sell off its Gilts Book – but it demonstrated the wisdom, competency and experience of the Bank.

As the facts changed – the bank changed policy. Smart. Wise. Credible.

The Bank did its job, averting a potential systemic risk crisis swamping the Gilts Market and potentially crushing UK real money investment firms. Had it not been sorted, we could have had a repeat of the 2007 Northern Rock run on the investment industry.

The problem was essentially a simple one – pension funds meet their obligations to pay pensions using Liability Driven Investment (LDI) instruments. Nothing onerous in that, but when the Gilt market went chaotic after Friday’s not-a-budget it triggered margin calls on aspects of these trades. The industry is long-term stable, but this was a short-term shock. The pension funds were forced to sell assets to raise cash to meet these calls. In times of crisis you sell what you can – not what you want to. Which meant the largest holders of Gilts were forced to sell Gilts into an already crashing market. The Bank applied the break! Saved the day.

Financial professionals understand what happened, and the bulk of us respect the Bank for demonstrating wisdom and credibility in a time of crisis.

Not so Government Cabinet Ministers.

I am told Ministers and supportive MPs have been given a list of talking points from Kwasi Kwarteng’s lair. They are straight out the Lyons/Minford/Odey playbook. Number three on that list is: Blame the Bank of England. On media they have been told to tell listeners the reason for the current crisis is The Bank failed to anticipate inflation or prepare for it, and the reason Gilts collapsed last week was due to them announcing the Quantitative Tightening (QT) sale of its Gilts book. I watched the Rt Hon John Redwood, Minister for Business Dumbf*ckery, on Channel 4 tell the Camera with a straight face it was the Federal Reserve raising US rates and the Bank announcing its QT programme that triggered the Gilts collapse – nothing to do with the Not-a-budget.

Today I am confident I will hear a Govt Minister call for an immediate investigation into Pension funds using dangerous and volatile LDI linked swaps and derivatives, and that they and The Bank should be castigated for putting innocent pensioners at risk. Lie and deflect. Lie and deflect. Repeat till it sticks.

I don’t like being patronised or lied to…

Rather than me say again what I’ve been writing all week, Editorial Board of the Financial Times says it rather well:

“The ructions since Friday’s cavalier mini-Budget have shown that governments cannot flout due process, independent oversight and economic expertise. By severely undermining the UK’s economic and financial integrity, the new Conservative administration is gambling with British people’s money, pensions, and homes. The BoE can only prop up markets for now, but regaining UK credibility will be the task of the government. It must do so with haste.”

I have only been in the Fixed Income Bond markets for 37 years. I freely admit I have a massive amount still to learn. What I do know is: In Bonds there is Truth. Bonds are the bones and financial plumbing of the global markets. They set the base, the rate from which all investments are measured. When the bond market breaks – so does everything else.

As I’ve described so many times in recent days – the UK was a solid financially stable economy. There were periodic wobbles, but we broadly met the Virtuous Sovereign Trinity of a competent political economy, a stable currency, and a sustainable bond market. The institutions created to ensure financial stability – The Bank, The Treasury, The Office for Budget Responsibility, The Debt Management Office, and market participants understood the way the tripod of government competency, sterling and gilts combined and functioned.

Then along comes Kwasi Kwarteng, enabled by Liz Truss, who has been noticeable only by her absence these last few days.

Kwasi had some limited experience in banking and hedge funds before he became an MP, rose to become a minister, and was elevated by Truss to Chancellor – 24 days ago. He came in with a plan and launched it. He turned down advice and a costing from the OBR. It’s now clear he did not heed advice from the Bank or DMO, did not share his plans with them, and sacked his Treasury secretary. Kwasi, who was once on University Challenge, decided he knew best.

It was not about the tone-deaf policies on banker bonuses or the 45% tax cut that crushed his plans – they are frankly irrelevant. It’s about a Chancellor who thought he knew better than the great financial institutions of the land, their collective expertise and experience, rejecting their inputs to come up with a childish notion he could finance short-term spending and a series of income and stamp duty tax cuts with long-term borrowing. It was beyond naïve.

As has been said before: “Kwasi Kwarteng is a man so fond of his own voice, his ears have been made redundant.”

The problem is we now have tidal waves of consequences threatening to overlap the economy. Yesterday The Bank nipped a pensions crisis in the bud. Tomorrow it faces a massive mortgage crisis which will rock the UK Housing Market. When housing collapses the 15-20% real estate firms expect, it will deepen the recession about to overwhelm the UK. Then the Bank will face a wave of corporate defaults as recession bites.

Meanwhile it faces the ongoing inflation crisis – which is not just a record rise in food prices, the Energy Price-cap bailout, but is now morphing into wage-demand real inflation. Industrial strife this way comes.

The tools at the Bank’s command are limited. They can raise or cut interest rates. They can use monetary instruments like QE – but these have consequences. It does not help they had to effectively pump money into the pension system yesterday (inflationary) when they need to hike interest rates to address the currency collapse, and fight inflation.

It’s not easy being a central banker.

Especially when incompetent politicians are looking for someone to blame.

The Government of Kwasi Kwarteng and his sidekick Liz Truss is not going to admit blame. They will not admit they did not listen to advice, accept responsibility or be accountable for the utterly unnecessary “policy mistake” that’s crushed confidence in the UK. They will cling to their narrative – its Remainer “haters”, it’s the pinko media, it’s the Bank of England, its rising global interest rates, it’s the Fed, and they will detract and deflect by saying its worse in Europe.

Whateva..

Liz and Kwasi will not ‘fess up and admit they were wrong. Until Government accepts it screwed up and some heads roll, or is replaced by due electoral process, they will cling on by their fingernails – which is not good politics. Larry Summers will be right – the UK economy will become a third world crisis. When their biggest supporters are hedge fund managers profiting from shorting Gilts and Sterling – well, do I have to spell it out?

Truss and Kwarteng will not step back. They are 4 weeks into a new Government – but have the biggest credibility gap in recorded history.

That is excessively bad news for the UK. Nothing to do with their politics, but it will mean gridlock in parliament to address the ongoing economic crisis that could engulf the nation, the geopolitical issues with China, the ongoing war in Ukraine and the need to invest in defence, plus the long-term issues of the environment and global warming.

If we face the next two years of incessant political strife and yet another lame duck administration – things will only get worse. Can’t we just get it over and done with?

Lis Truss should let the country decide – we should press the Reset Button and have a General Election.

Five Things To Read This Morning

FT – The Jeopardy for banks in Kwarteng’s City chaos

BBerg – The UK Cannot Afford to Look This Ridiculous

Guardian – Tory MPs tell Truss: Sack Kwarteng or face mutiny

WSJ – Global Bonds Rally After 10-year T-Bond Yield Touches 4%

Times – Government undercutting Bank of England, says Mark Carney

Out of time, out of patience and back to the day job. Tomorrow I’m going to write about anything else….

Bill Blain

Shard Capital