Its Over

...Bailey has not learn what it takes to be a central banker, you can't show your cards to the market...the market is always trying to bet what they will or won't do. Now possibly the market will call Bailey's bluff and test his resolve.

....and we can guess how this ends. At present Kwarteng would only reveal his fiscal strategy plan on Halloween day, which could drag out this uncertainty that the markets have come to learn. But if the turmoil continues on or after Friday, Kwarteng would be forced to show his plan sooner...and my guess is it ends when he either does a complete 360 degree turn on his tax cuts or the Truss Govt is forced to resign via a vote of no confidence. Even then, two weeks of great uncertainty is too long to wait...what more on the eve of the FOMC meeting on Nov 1-2.

..as this thread has said long ago, there are lots of risks underneath the surface, including derivative products no one has ever heard of , like LDI which the UK pension funds used to hedge, waiting on a spark before imploding. It usually does not become a problem until it does.

...meanwhile Treasury Sec Janet Yellen does not think there's market instability big enough to worry about. LOL. Understand, she is too important a person to sound out that we should be concern. Confidence is paramount. This is just a UK problem, not ours. Move on. Except that it is undeniable that we are in an interconnected global market.

...your risk is not limited to just the funds you invest in, it is also the party managing and responsible for them. The funds get into losses, you can recover them over time. But if the entity responsible for them gets into financial trouble, you have no way of recovering. Am sure many crypto holders learnt it the hard way. Its call COUNTER PARTY RISKS and REDEMPTION RISKS.
Larry Summers’ contagion warning for investors

The Bank of England’s mishandling of the crisis in Britain’s bond market risks a sort of pyschological contamination, the veteran economist says.
Oct 12, 2022 – 11.39am

At the ripe old age of 67, veteran economist, academic and former US Treasury secretary Larry Summers cheerfully admits he’s “been doing this a long time”.

But over that long career, Summers says he’s never seen something quite as dumb as the combination of policy and policy communications that Britain’s Tory government has deployed over the past month, which has led to a crisis in UK bond markets that shows no sign of ending.

Former Treasury secretary Larry Summers is worried about contagion. Bloomberg
First came the enormous energy subsidies and a commitment to lift defence spending despite raging inflation. Then came the now-abandoned tax cuts. And then there was a stuttering attempt by the government to backtrack as the pound crashed and bond yields surged.

“When you alarm the markets that bad, and you’re still working on your plan to unalarm for more than a month, it’s not usually reassuring,” Summers says.

But Summers, speaking at Citi’s Annual Australian Investment Conference from his home in the US on Wednesday morning, also took a swipe at the Bank of England’s efforts to stabilise British bond markets.

Yields on gilts have continued to surge in recent days as pension funds dump long-dated bonds to meet repeated margin calls against their holdings in liability-driven investment funds that are ironically designed to smooth out the effects of inflation.
On Tuesday night, the BoE said it would widen the bond-buying program it started last week to include inflation-linked gilts, after warning “the prospect of self-reinforcing ‘fire sale’ dynamics pose a material risk to UK financial stability”.

But BoE governor Andrew Bailey also declared the bank will end its intervention in three days’ time, telling pension funds to have their house in order.

Summers clearly thinks little of those tactics, and fully expects to bond investors to test the BoE’s resolve in the coming days.
“I would have thought that by now, it was something that should be universally understood that if you’re making a military intervention in a country, it’s a terrible idea to announce the deadline by which you will withdraw. Because it just provides a roadmap for your opposition and encourages them to wait you out.

“And I would have thought exactly the same principles apply to a last resort finance operation. Where if you say it’s all going to end at a certain point, you just encourage the speculators to wait until the moment when it ends.”

‘Be more careful of everything’

The 1 per cent fall on Wall Street on Wednesday night, Summers says, is in part a reflection of contagion from the instability on markets, where forced selling by pension funds is continuing – even ASX-listed fund managers such as Magellan and GQG have experienced that.

But the bigger contagion, Summers argues, comes from reputational or psychological contagion. That is, markets didn’t expect that higher interest rates would create cracks in this area of the market, and so they have become wary of where the next unexpected shock might come from.

“This is the beginning of a process, it’s not the end of a process,” Summers says. “There’s probably going to be more illiquidity. I don’t know where it will happen. But I should just be more careful about everything.”

Summers sees looming tension between central bank concerns about financial stability and their worries about inflation, but believes the US Federal Reserve is committed to its inflation fight.

He expects that fight will be harder and more painful than investors expect; while the market’s current expectation is that the Fed hikes to a peak of 4.5 per cent, Summers guesses rates might need to go higher than that.

A big reason is the state of the US labour market. Following the Great Resignation and what Summers calls the Great Reorganisation that has heralded the rise of remote work, Summers estimates the neutral unemployment rate - that is, where unemployment is neither contributing to economic expansion or contraction - has probably risen from 4 per cent to 5 per cent. This means the US unemployment rate may need to go to 6 per cent for inflation to meaningfully fall.

Still, Summers recognises that a Fed pivot – a shift towards smaller rate rises or a pause entirely – is possible. He points out that the vaunted inflation-busting Fed governor Paul Volcker, who took US rates to 18 per cent in the late 1970s to try to contain inflation, took a couple of tightening cycles to do the job.

“So if even Paul Volcker had a kind of false start in containing inflation, I think we’ve got to recognise that’s a real risk in the current situation.”