A systemic global financial crisis is being previewed in the UK……

In the past two days, an extremely significant event occurred in the international financial markets, but was ignored by most domestic financial media.

What we are concerned about is the big rise in U.S. Treasury yields, the stock market plunge and so on……

Unbeknownst to us, a systemic financial crisis has begun to play out in the UK.

Let’s look at the performance of the market first.

On September 22, after the Federal Reserve and the Bank of England announced their interest rate resolutions, the UK’s long-term Treasury yields, followed by a big rise, that is to say – a plunge in Treasury bond prices.

On September 23, the UK’s Truss government, announced its £45 billion tax cut plan, and where will the money for this tax cut come from? The British government will issue new long-term treasury bonds to finance it – that is, Truss is borrowing money to cut taxes.

Every day for five days from Sept. 22 to Sept. 27, the yield on Britain’s long-term government bonds jumped, with the yield on its 20-year bonds rising from 3.6 percent to 5 percent (see the chart below), the fastest rise in decades for Britain’s long-term government bonds.

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Note that I’m only mentioning the 20-year UK government bond here, but in fact, yields on long-term government bonds, including the 10-year UK government bond and all other maturities, have been rising at almost the same rate.

Along with the sharp rise in UK government bond yields, the UK stock market and the British pound exchange rate have plummeted, and the UK financial markets have seen a real “triple kill” of stocks, bonds and currencies, which I have discussed in my article two days ago.

“The stock, bond and exchange triple kill, the pound’s worst moment in 200 years”

By September 28, that is, this Wednesday, from the early hours of London time, the British long-term government bond yields and suddenly plummeted, 20-year bond yields, within a day from 5% back to about 4% (see above), and the exchange rate of the pound, also from the lowest point 1.04 swift

Well, review the British financial markets within a few days of the huge shock after.

The first step, on September 22, the Federal Reserve rate hike and the Bank of England rate hike, triggering an impulse rise in British Treasury yields

the second step, on September 23, the Truss government announced a £45 billion debt-financing tax cut plan, exacerbating the market sell-off in British long-term government bonds, which sent British long-term government bond yields soaring and the pound exchange rate plummeting.

Step three, numerous UK pension funds, which have seen their asset side shrink sharply as a result of the plummeting Treasury bond prices, need to make huge margin calls.

Fourth step, in order to meet the margin requirements, pension funds began to sell long-term British Treasury bonds in stages, thus, causing a stepped plunge in the price of long-term British Treasury bonds (yields stepped up), the more pensions sold, the higher the yield on Treasury bonds, the faster the asset side of these pensions, the shrinkage, the death spiral opened.

The fifth step, see the British financial system to a big problem, the Bank of England decisively down, printing money to buy treasury bonds, unlimited purchase of long-term treasury bonds, which quickly pushed up the price of long-term treasury bonds (lower yields), but contrary to the Bank of England announced shortly before this decision to reduce the balance sheet.

Even the International Monetary Fund (IMF) could not sit still, they came out and “brutally interfered” in the UK’s internal affairs, criticizing the UK Truss cabinet’s tax cut plan in a rare move, urging the UK government to “reassess” the plan, warning that The “untargeted” package of tax cuts could trigger a spike in British inflation.

The process of the huge shock in the British financial markets is clear, and we will now analyze the reasons behind it and its possible impact.

The problem starts with the many pension funds in the UK.

We know that the process of pension funds are operating by collecting money now and then paying you a pension regularly when you are old, and this process of operation involve two issues.

One is the maturity matching of funds (matching funds now with funds decades in the future).

One is the investment income of the fund (the investment income in the past, can cover the capital expenditure in the present and in the future).

In order to maintain the stability of the pension fund’s income, most countries’ laws have clear restrictions and regulations on the assets invested in the pension fund, and most of the pension fund’s money must be invested in safe fixed income.

What is the safest fixed income?

Treasuries, of course!

However, for liabilities that are decades away (the money that pensions need to spend now and in the future is a liability), the uncertainty of interest rates and inflation is so high that pension funds use a lot of interest rate swaps (IRS) in the financial markets to match interest rate risk and inflation swaps (IRS) to match inflation risk. To match inflation risk

How does this work?

Isn’t there a fixed interest income on the treasury bonds that the pension fund buys? By entering into an agreement with an investment bank, I swap this into a floating interest expense that follows the market, which is the IRS.

Because IRS requires only a small amount of collateral to be paid to the investment bank, you can get a long term funding matching contract, and the money saved, the pension can buy higher yielding stocks or corporate credit bonds, thus meeting regulatory requirements and achieving time matching of assets and liabilities, as well as taking into account the return on the asset side.

It can be said to be killing three birds with one stone.

In the past nearly 30 years, including the United Kingdom, the world’s major countries, interest rates are all the way down, inflation has always been located at very low levels, in this case, the collection of fixed income, expenses floating income, how pension institutions are making money, IRS to achieve maturity matching, but also risk-averse, but also to save money, money, that is really cool!

One word: cool!

The happy days were not short-lived and lasted for more than 20 years.

However, since the outbreak of the global financial crisis in 2008, the British government bond yields, a round of lower than a round, so that the IRS certainly for the pension fund to save money, but also earn money, but at the same time, these pension institutions new purchases of medium and long-term Treasury bonds, the annual fixed income that can provide less and less……

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Then, there is the spike in inflation + spike in interest rates in the UK since 2022.

Because of the spike in interest rates, the floating interest payments, compared to the fixed returns on the long term treasury bonds purchased by pension institutions, now come out a whole lot higher, which means that the IRS is generating massive losses.

This loss, which would not have been much of a problem, should have been expected, but the bigger trouble is – the Treasury collateral provided by pension institutions to investment banks, because of the rapid spike in yields and plummeting prices.

Originally, if the time was stretched out, pension institutions could make up for the IRS losses through new high-yield investments, and also allow the value of the collateral to keep up with the investment banks’ requirements, but the rapidly rising UK Treasury yields did not provide pension institutions with such a time cushion and opportunity.

For investment banks, our IRS agreement you have lost money, and the price of the assets you pledged to me has plummeted, you will need to provide more collateral, plus your losses, and you will have to provide a lot of cash to me for margin.

In order to raise cash, pension institutions had to choose to sell some of the long-term British Treasury bonds, this selling, resulting in long-term Treasury yields further lift; this time, Truss’s Treasury bond financing big tax cut plan, and a godsend, intensified the long-term Treasury yields lift; this lift, in turn, led to further expansion of the pension fund’s IRS book losses, also led to the pension institutions collateral values to fall further, and then, in turn, investment banks needed more margin and collateral ……

In this way, the UK financial markets are rapidly descending into a death spiral.

This is exactly why within the past week, British government bond yields have continued to skyrocket abnormally and the value of the pound has fallen below the 200-year low exchange rate with the dollar!

Had to, the Bank of England took action.

London time on September 28 at 10:00 am, the Bank of England suddenly announced that temporarily postpone quantitative tightening, and an unlimited increase in the purchase of long-end Treasury bonds, giving the reason that “the market is out of whack, there are risks to financial stability.

By September 29, the Bank of England again confirmed that it would urgently buy 65 billion pounds of British government bonds to stabilize the market.

 

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