U.S. currency in a bull market.
We find ourselves in the lap of the gods.
A desperate economic crisis is not fate, yet every day we grind close to the abyss. The U.K. is the ‘”canary in the coal mine.” The U.K.’s sovereign bonds nearly imploded and it took unprecedented intervention to save the day. The narrative has been a political one, but in reality the whole global economy is hanging by a thread because the U.S. Federal Reserve has created a runaway dollar that is crushing everyone else’s currencies.
The Federal Reserve is in effect exporting its inflation to the world via its reserve currency position where the ingredients of things are made and priced in dollars but made and imported in weakening non-USD currencies. Dollar up = commodities down. Dollar up = import prices down. The Federal Reserve’s hawkish anti-inflationary action is dumping dislocation on any economy not prepared to hike its interest rates into an economic recession. Unlike the U.S., that can vacuum up offshore dollars and funding, other countries find themselves in the position of “emerging economies,” suddenly being out of funding and out of luck.
The U.K. is the smallest economy of the major non-haven currencies and as such it is feeling the boot heel of the U.S. Federal Reserve on its neck the hardest.
The Liz Truss debacle is simply the first market response to the new generation of “give away” money politicians, but the underlying problem is the legacy of debt from the “Covid response” and the lack of a proper bounce back of economic affairs.
The revealed dead elephant in the room is the levering up of sovereign debt by financial institutions. This has the potential to tip the world into the “global financial crisis part 2” but this time at a scale an order of magnitude bigger.
If you borrow money using government debt to buy more that seems pretty dangerous, if interest rates go up you get a margin call and likely you sell off your assets and then go bust… but it is worse.
This leveraged trade will have been funding all these government huge debt issues because the leverage creates a massive extra demand for government debt, and if you unwind that process suddenly there is no one to buy government debt because the previous customers were buying 5-10 times the amount they should have and now, if they don’t go bust, certainly won’t buy more than 1x of what they need. So apart from spiking interest rates to the moon, the question is then, who will buy government debt? It’s a potential death spiral for the way governments have been funding themselves, perhaps even a death spiral period. The only way out would be a huge inflationary print-a-thon.
We will have to get months down the road before this nightmare vision is proven to be a dark hallucination.
So here is the FTSE chart and how the set up looks from the point of view of the hive mind of the market:
The FTSE chart
A bear will quickly see 6,000 or worse:
The bearish view of the FTSE chart
It is all down to the U.S. If the world settles in to a 5%-7% inflation for a few years, after a Fed pivot, the world economy won’t crack, but that means the U.S. cannot do a “‘Volker” and go on the path of punishment as a cure to inflation, because that will undo the rescue that took place in 2020-2021. Currently it is on that road.
The damage was done by the Covid pandemic and flogging the dead horse with high interest rates won’t repair losses already made.
The only chance is that talks of austerity are just that, jawboning. If they are not then the downside really is truly titanic.
People are wishing the Federal Reserve will pivot but I think that is just “TINA” talk. If they do not pivot soon, then the markets will start to malfunction and that moment is close.
