Friday, September 30, 2022

"Who exactly has the BoE bailed out?" (you mean in addition to BlackRock?*)

I had not yet seen this article when I was busy casting aspersions: 

Fed Balance Sheet: Why Are Central Banks So Terrified Of Quantitative Tightening?

It has to be derivative positions held by so-called capitalists [the old-boy privatize the profits, socialize the losses crowd]. Witness the Bank of England's first impulse when confronted with trouble in the gilt market: not just halting QT but reversing 180 degrees to buying bonds.

Ditto the U.S. Federal Reserve: like a magician's misdirection, they attempt to focus the public on their interest rate moves and wave their hands when asked about the Treasury and MBS portfolios....

But what follows is as good an explanation of the 'ol cui bono that I've seen. First though, if the reader desires a brush-up, here's Investopedia's entry for "Liability Driven Investment (LDI)"

And from FT Alphaville, September 30:

Who exactly has the BoE bailed out?
A deep dive into run dynamics and liability-driven investment pools

When we left the story on Wednesday the Bank of England had just swooped in with an emergency intervention in the long-dated gilt market to break the doom loop.

Its move is likely to have exceeded all expectations of success. A 100 basis-point rally! Doom loop broken! Wow!

But has the BoE bailed out the pension funds? Or did it bail out the pension fund managers? Some amazing FT reporting shed some light on the question, and the answer looks like it might be more complicated.

While some schemes continue to rush to raise cash to fund their derivatives positions, others have had the positions terminated by LDI managers, including BlackRock, leaving them exposed to further moves in rates and inflation.

Natalie Winterfrost, a professional trustee with Law Debenture, said: “There are definitely schemes that were forced out of the game. There are a material number of schemes that will have ended up unprotected, with many more fully unhedged. If gilt yields fall further then their funding positions will deteriorate.”

Simeon Willis, partner at XPS Pensions Group, said: “There could be many hundreds of schemes that have had their hedges reduced or removed. This means their funding positions are now much more vulnerable than they were a week ago.”

What is not specified is exactly when derivative positions were terminated by LDI managers such as BlackRock, or when schemes were “forced out of the game”. (Update: BlackRock says it has “been reducing leverage in some of our LDI funds, acting prudently to preserve our clients’ capital in extraordinary market conditions. Trading in BlackRock funds has not been halted, nor has BlackRock ceased trading in gilts.”)

If this all happened after the Bank intervention, it’s not a huge deal. If this happened just before the Bank intervention, it is. In fact it’s horrific.

Let’s unpick this astonishing whipsaw scenario — where hedges that link the value of assets to the present value of liabilities are removed immediately ahead of the BoE intervention....
The author of this piece, Toby Nangle, ran money at Columbia Threadneedle until earlier this year. On July 20 he wrote "The big collateral call facing UK pension funds".
Additionally some of the commenters are also pretty sharp.
*Legal & General and Schroders were also purveyors of the putrid product.

Société Générale's Albert Edwards Has A Different View Of UK’s Historic Week

From The Heisenberg Report, September 29:

The ongoing crisis in the UK may not be all Liz Truss’s fault.

I’m certainly inclined to suggest that a little foresight on her part might’ve gone a long way towards preventing the highly unfortunate series of events that transpired in the days since Kwasi Kwarteng unveiled unfunded tax cuts as part of a broader package of measures aimed at rescuing the economy from a prolonged recession. And I’ve (obviously) been a staunch critic of Truss’s handling of the nation’s burgeoning financial crisis.

But, as SocGen’s incorrigible, yet exceedingly affable, bear, Albert Edwards, was keen to point out Thursday, it might be unfair to put the blame solely on fiscal policy.

“I believe it’s too easy to blame the budget’s dash for growth as the trigger,” Edwards wrote, in a new note. “Indeed, the recent unprecedented criticism of a G7 budget by the IMF just reinforces my view that the Davos-consensus on the ‘correct’ economic policies to pursue were never going to tolerate someone trying to break away from the pack without trying to bring them into line,” he added.

For Albert, the BoE’s “failure” to hike 75bps last week in lockstep with the Fed, and the bank’s concurrent decision to move forward with gilt sales (i.e., QT) set the stage for the historic meltdown in UK government bonds (figure below).


He did, however, concede that Kwarteng was “unsuspecting and overly complacent.”

I’ve noted on multiple occasions that the juxtaposition between new gilt issuance to fund the growth plan and the BoE’s QT efforts was indeed a contributing factor to the collapse in gilts. I just don’t necessarily agree with Edwards on the sequencing. The BoE telegraphed its QT intentions months ago. The market was well apprised.

In any event, there’s no question that the tension between the government issuing more debt and the central buying less of it was part and parcel of the problem. “One could reasonably suggest,” Albert said, that going ahead with active gilt sales “at a time when global bond markets were already under severe pressure was foolhardy.” I won’t argue that. Not for a second.

Edwards is, of course, a dedicated contrarian. It’s not surprising that he’d push back on the official narrative, but I’d be remiss not to concede that he’s closer to the crisis and infinitely more familiar with the Bank of England than I am, so I’d be derelict not to at least highlight his views during this historic week....


"Do Tight Labor Market Conditions Keep Core Inflation Sticky?"

Something sure is sticky. 

An excerpt of the BEA Personal Consumption Expenditures deflator measure from the post immediately below:

Personal Consumption Expenditures Price Index, Excluding Food and Energy

The PCE Price Index Excluding Food and Energy, also known as the core PCE price index, is released as part of the monthly Personal Income and Outlays report. The core index makes it easier to see the underlying inflation trend by excluding two categories – food and energy – where prices tend to swing up and down more dramatically and more often than other prices. The core PCE price index is closely watched by the Federal Reserve as it conducts monetary policy.

Quarterly and annual data are included in the GDP release.

Change From Month One Year Ago
August 2022 4.9 %
July 2022 4.7 %
June 2022 5.0 %
May 2022 4.9 %

May to August rate of increase being UNCH brings to mind a quote from Warren Buffett.*

And from Mike Shedlock at MishTalk, September 28 [quick note, for our purposes the biggest difference between PCE and CPI is that PCE weights shelter at half the weight that CPI does]:

What's the role of tight labor markets on core inflation and overall inflation?

CPI components as of August 2022. Chart by Mish.

CPI components as of August 2022. Chart by Mish.

Core CPI is defined as everything but food and energy. Here's the set of claims I am investigating....

*and Mr. Buffet on the closing level of the Dow Jones Industrial Average:
December 31, 1964: DJIA 874.12
December 31, 1981: DJIA 875.00
“Now I’m known as a long-term investor and a patient guy, but that is not my idea of a big move.”
-Warren Buffett
We first shared that quote in 2008. 
The above is from 2012's "Meet Warren Buffett, High Frequency Trader (BRK.B; INTC; WFC)" which I thought was a pretty funny headline. (maybe you had to be there)

The original was in this 1999 Fortune article "Mr. Buffett on the Stock Market"

"Fed's preferred measure of inflation shows prices surged again last month"

From CNN via MSN, Sept 30:

After hitting an alarming 40-year high in June, the Federal Reserve’s preferred benchmark for consumer inflation is once again flashing a warning sign about the persistence of high prices.

The Bureau of Economic Analysis said Friday the Personal Consumption Expenditures price index for August rose by 6.2% from a year ago, following a revised July reading of 6.4%. That was viewed as a driver behind the central bank’s decision to raise its benchmark rate by three-quarters of a percentage point for the third time in a row earlier this month.  

Looking at month-to-month data, the PCE price index rose by 0.3%.

The core inflation measure, which excludes the volatile categories of food and energy and is the number watched most closely by Fed policymakers, rose by 4.9% on a year-over-year basis in August, up from 4.7% in July. Core PCE surged by 0.6% for the month, a spike from July’s revised 0%.

The latest inflation data puts more pressure on Fed Chair Jerome Powell, who has vowed to make taming inflation the central bank’s “overarching focus.”

The August Consumer Price Index, another major inflation gauge, surprised economists in mid-September with a core reading for the month that rose instead of fell as expected.

The Fed has been battling to get runaway inflation under control for months by raising its benchmark interest rate, initiating the most aggressive tightening cycle in four decades with a total of five increases so far this year, including three back-to-back hikes of three-quarters of a percentage point each.

But, to date, economists say the extent to which headline inflation has moderated — which is minimal to begin with — is almost entirely a function of lower energy costs. This is reflected in the stubborn persistence of high core inflation, which backs out energy as well as food prices....


MarketWatch via MSN headlined it this way:

Cheaper gas holds down U.S. inflation, PCE shows, but the cost of everything else is still going up fast

And from the Bureau of Economic Analysis:

EMBARGOED UNTIL RELEASE AT 8:30 a.m. EDT, Friday, September 30, 2022
BEA 22-47

Personal Income and Outlays, August 2022 and Annual Update 

Portents: "Amazon to Close 4 of its 5 US Call Centers, Shifts to Work-from-Home, after Closing 44 Warehouses, Halting Construction on 7 Office Towers " (AMZN)

From Wolf Street, September 29: 

The giant’s footprint reduction to cut costs sinks Commercial Real Estate.

Amazon, which booked net losses in Q1 and Q2 totaling nearly $6 billion and whose shares are down 38% from their high in July last year, is undertaking large-scale efforts to cut costs – including commercial real estate costs. It is closing or cancelling 44 warehouses across the US; it’s halting construction on six office towers, and won’t start construction on a seventh. And now it emerges that it plans to close four of its five call centers in the US and switch those customer service representatives to working from home.

Amazon currently operates five call centers in the US. Kennewick, WA; Lexington, KY; Phoenix, AZ; Huntington, WV; and Houston, TX. It plans to close four of them. Either the Houston or the Huntington facility will likely remain open, according to Bloomberg, citing a source.

Amazon confirmed to Bloomberg that the call center work will be shifted to work from home. Even before the pandemic, it already allowed some call center workers to work from home.

“We’re offering additional members of our customer service team the increased flexibility that comes with working virtually,” an Amazon spokesman told Bloomberg. “We’re working with employees to make sure their transition is seamless while continuing to prioritize best-in-class support for customers.”....


July 30
ICYMI: Amazon Has Shrunk Its Payroll By 100,000 (AMZN; GOOG)
May 23
Logistics/Warehouses: "Amazon Seeks To Offload Up To 10 Million Square Feet Of Warehouse Space" (AMZN)

....Well, it was a good run.

Starting in June 2019 until, huh, February
But there was already something in the air by last May:

Logistics: "Amazon is fuelling North America's worst warehouse shortage....and it's right here in Canada"
There were no stories like this when we began pitching warehousing and cold storage. It may be time to exit the portfolio investments and, if your mandate says you have to have commercial exposure, consider owning the cash flow directly. Always a tricky transition though..
Probably the high point: Dec. 13, 2020:
Real Estate: "Logistics market is hot, but is a bubble forming?"
It's always nice to see a sector you've been babbling about for a couple years finally referred to as a bubble.
That post has some of our previous links, there are many, many more; use the 'search blog' box if interested.

And by December 2021:

Big Money Still Buying Warehouse Assets: Canada Pension Plan Investment Board Enters Into $1.1 Billion J.V.
We on the other hand got bored after pitching them for three years and moved on to something shiny - Look, an NFT!

So, once again, short attention span investing proves to have some risk management qualities.

And if you know anyone looking for an NFT or twenty, I know where you can get your hands on some.

No Bored Apes though, a pox on the Bored Ape crowd.

Fed Balance Sheet: Why Are Central Banks So Terrified Of Quantitative Tightening?

It has to be derivative positions held by so-called capitalists [the old-boy privatize the profits, socialize the losses crowd]. Witness the Bank of England's first impulse when confronted with trouble in the gilt market: not just halting QT but reversing 180 degrees to buying bonds.

Ditto the U.S. Federal Reserve: like a magician's misdirection, they attempt to focus the public on their interest rate moves and wave their hands when asked about the Treasury and MBS portfolios.

Here are the latest numbers from the H.4.1 report dated September 29, 2022 for the week ended September 28. Keeping in mind that the Fed's new reduction targets, starting September 1, are $60 billion per month (~$2 billion per day) for treasuries and $35 billion per month (~$1.1 billion per day) for mortgage-backed securities:

1. Factors Affecting Reserve Balances of Depository Institutions

Millions of dollars

Reserve Bank credit, related items, and
reserve balances of depository institutions at
Federal Reserve Banks

Averages of daily figures

Sep 28, 2022

Week ended
Sep 28, 2022

Change from week ended

Sep 21, 2022

Sep 29, 2021

Reserve Bank credit


-   10,846

+  347,605


Securities held outright1


-   10,258

+  442,463


U.S. Treasury securities


-    2,091

+  253,718




-    2,078

-   12,396


Notes and bonds, nominal2



+  217,067


Notes and bonds, inflation-indexed2



+   13,007


Inflation compensation3


-       13

+   36,040


Federal agency debt securities2





Mortgage-backed securities4


-    8,167

+  188,746



As we've said for three and a half months, because the Fed is not selling outright but rather allowing paper to roll off as it matures the per day and even the per month figures are idealized, some weeks more, some weeks less but for the MBS paper this is only the second week in 17 that the decrease was anywhere near the target, with the cumulative shortfall at $75.2 billion.

As to the much more liquid treasury portfolio they have a cumulative shortfall since the much-heralded program began June 1 that I haven't bothered to calculate but which this report's $12 billion shortfall only exacerbates.

Here is the St. Louis Fed's graph of the total balance sheet including much smaller line items such as interest due the Fed and other receivables which: a) aren't part of QT and b) tend to average out over time but on a weekly basis can impact the total balance sheet reduction or increase. Again, the program started on June 1, not at the high point of the graph on April 13 (mouseover interactive):

As can be seen, the week's total reduction of -$21.235 billion is much larger than the reduction in the QT items (-$10,258 billion). If interested the reader can follow the "MUCH MORE" link to table 5 of the report for the details, quick and dirty the excess was in the value of treasuries, mortgages are carried at face.

Re/Insurance, Cat Bonds: "Hurricane Ian industry loss estimated up to $40bn by Fitch" ($25 - $40 billion)

 From Artemis, September 30:

Another data point for those looking at the implications of major hurricane Ian’s path through Florida, rating agency Fitch says the insurance and reinsurance market loss is likely up to $40 billion.

Fitch Ratings said that, based on its initial analysis, insured losses from hurricane Ian could range from $25 billion to $40 billion for Florida alone, with a potential increase possible depending on how severe the impact of Ian is in the Carolinas for its second landfall.

At these levels of insurance and reinsurance market loss, Fitch said that while “substantial” they are unlikely to affect credit for rated property & casualty (PC) re/insurers, given ample capital levels and their ability to increase premium rates.

On the other hand though, Florida insurance specialists that are unrated by Fitch are deemed more exposed and “at risk”, the rating agency said, especially as these companies have already suffered financial losses and diminished capital in recent years, making them particularly vulnerable to large catastrophe events that result in losses in excess of reinsurance limits.

Fitch Ratings early estimate compares to CoreLogic’s range of $28bn to $47bn and adding further weight to the calls for the eventual industry loss to be something well in-excess of $30 billion, it now seems....

....MUCH MORE, and links to some of the prior estimates.

"How Germany's industrial giants are preparing for winter"

From Reuters, September 27:

Germany has managed to fill its gas reserves to 91.32% of capacity, allaying fears it could run out this winter after Russian gas flows fell sharply following European sanctions over the invasion of Ukraine - but it has come at a price.

One in ten mid-sized companies, which provide nearly two thirds of German jobs, have cut or halted production because of gas prices, according to a September survey of nearly 600 mid-sized firms by business association BDI, reducing demand.

Some industrial giants in particular gas-heavy industries like chemicals have begun shifting production and sourcing from elsewhere, while others are switching from gas to coal or oil - spelling trouble for their carbon footprint.

Below is an overview of what steps some of Germany's biggest industrial firms have taken to reduce their gas intake in anticipation of winter, and which are holding out for more information on government measures before cutting their consumption further.

Firms are listed in alphabetical order.

The world's largest chemicals company has reduced production of ammonia, a nitrogen fertiliser and input for engineering plastics and diesel exhaust fluid which relies heavily on natural gas.

It is now sourcing some of its ammonia from outside of Europe, where prices are lower, a spokesperson said.

BMW consumes around 3,500 gigawatt hours (GWh) of energy annually in Germany and Austria, three-quarters of which comes from natural gas.

The carmaker can reduce its gas intake by at least 15% compared to last year, the company's chief financial officer said on Monday.

CEO Oliver Zipse said in August it could replace around 500 GWh of electricity from gas-powered combined heat and power plants by buying electricity from elsewhere but that doing so would significantly bump up its costs....


"Is Deflation A Risk, Or Are These Prognostications A Spurious Call For A Fed Pivot?"

From Joe Carson at The Carson Report, September 29:

Consumer price inflation is at its highest rate in decades, yet some equity managers are screaming that deflation is the most significant risk. Is deflation a credible risk, or are these prognostications a spurious call for a Fed pivot? It's the latter.

First, the US has never recorded one year of deflation in core consumer prices in the sixty-plus years that the Bureau of Labor Statistics has collected data. Think about that. There have been several years of high unemployment, with the jobless rate exceeding 8% and a few at 10%-plus. Also, the US experienced record wealth losses following sharp drops in equity and real estate prices, abrupt drops in commodity prices, and near-collapse in the banking system in 2008-09, and not one year of a decline in consumer prices. That does not mean the future risk is zero. Still, going from high to negative inflation in months has to be exceptionally low. Also, economic and financial conditions would have to get significantly worse, above and beyond what has happened in the past, for a prolonged period before deflation risks would be the dominant worry.

Second, many equity managers form their opinion on inflation/deflation risks based on changes in commodity prices, especially energy. But, commodity prices are inputs into the production process and have a small weight in the overall cost of operations. Also, the US uses more commodities than it produces, so a fall in commodity prices is usually bullish for growth as it frees up cash flow and increases demand (and prices) in other areas....


Our introduction to a previous visit with the writer:

"Peak Inflation Is Hollow: It Provides No Context To Reduction in Speed or Duration of Cycle"
The author, Joe Carson is the former Chief Economist & Director of Global Economic Research at Alliance Bernstein. Prior to that he was Chief Economist at Chemical Bank and at Dean Witter, firms he left in such rough shape they were forced to merge with JPM and MS respectively. (Just Kidding Mr. C.)....

Thursday, September 29, 2022

Currencies: "DXY below 112.0 with GBP outperforming, EU Energy meeting looms - Newsquawk Euro Market Open"

 From ZeroHedge's newsqawk, September 30

  • APAC stocks were mostly lower after the negative performance across global peers (SPX -2.11%, NDX -2.86%).
  • European equity futures are indicative of a flat open with the Euro Stoxx 50 future unch. after the cash market closed down 1.7% yesterday.
  • DXY reclaimed 112 to the upside, EUR/USD maintained 0.98 status, whilst cable extended recovery gains to breach 1.12 at one stage.
  • EU senior diplomat said EU countries are nowhere near a consensus on a gas price cap.
  • Looking ahead, highlights include German Retail Sales, EZ CPI (Flash), Unemployment, US PCE Price Index, Russian President Putin, Moody's on Italy, Speeches from Fed's Williams & Brainard, ECB's Elderson & Schnabel.


The dollar index futures are at 111.90, down .30 and down from September 28's 114.75 print.

The pound is at 1.1143

An Entry From Samuel Pepys Diary, Thursday 28 September 1665

From The Diary of Samuel Pepys:

Up, and being mightily pleased with my night’s lodging, drank a cup of beer, and went out to my office, and there did some business, and so took boat and down to Woolwich (having first made a visit to Madam Williams, who is going down to my Lord Bruncker) and there dined, and then fitted my papers and money and every thing else for a journey to Nonsuch to-morrow. 
That being done I walked to Greenwich, and there to the office pretty late expecting Captain Cocke’s coming, which he did, and so with me to my new lodging (and there I chose rather to lie because of my interest in the goods that we have brought there to lie), but the people were abed, so we knocked them up, and so I to bed, and in the night was mightily troubled with a looseness (I suppose from some fresh damp linen that I put on this night), and feeling for a chamber-pott, there was none, I having called the mayde up out of her bed, she had forgot I suppose to put one there; so I was forced in this strange house to rise and shit in the chimney twice; and so to bed and was very well again, and [Continued tomorrow. P.G.]

HT: Bill Bailey, in one of his performances started talking about Pepys and read the diary entry but I've forgotten which show, probably one of the Royal Variety performances so instead of Mr. Bailey reading about Pepys pooping in the fireplace here he is playing with a very interesting orchestra and an astounding sitar player.

Even tech guy Siva, a street-wise Hindu boy (CalTech postdoc) who initially thought I was subjecting him to some sort of sitar blasphemy came around and said "They are very, very good."

Regarding Pepys, this is from April 2020 as the covid was gathering steam:

"Lessons in Death and Life from the Diaries of Samuel Pepys"

We don't have a lot on Pepys. There was the time he forgot the crustaceans in the carriage:
350 Years Ago Today: Samuel Pepys Forgot His Lobsters

And the time he was a placeholder for Ms Kaminska:
While Waiting for Izabella to Tell Us About Roman Brothel Tokens: The Trade Tokens of Samuel Pepys’ London

And a few more but all-in-all and especially considering the times in which he lived, not a lot.....


.....He also dropped in on us in "Resiliance, Brittleness and Catastrophic Failure: Everything Is Fine, Until It Isn't":

"Perhaps the most irrational fashion act of all was the male habit for 150 years of wearing wigs. Samuel Pepys, as with so many things, was in the vanguard, noting with some apprehension the purchase of a wig in 1663 when wigs were not yet common. It was such a novelty that he feared people would laugh at him in church; he was greatly relieved, and a little proud, to find that they did not. He also worried, not unreasonably, that the hair of wigs might come from plague victims. Perhaps nothing says more about the power of fashion than that Pepys continued wearing wigs even while wondering if they might kill him."
– Bill Bryson, “At Home: A Short History of Private Life”
And some of his correspondence was in "Oxford's Bodleian and the University of Michigan Libraries Release 25,000 Early English (1473-1700) Books to the Internet"

And some stuff from his time as President of the Royal Society, a couple years after Wren and a couple decades before Newton:
Digitized Minutes of the Royal Society 1686 - 1711

But not nearly as much as I would have thought.

Currencies: "Why a soaring dollar is raising questions — and doubts— about a Plaza Accord-style intervention"

 From MarketWatch, September 29:

The U.S. dollar’s historic rally is rattling investors and policy makers, raising questions, along with doubts, about a 1985 Plaza Accord-style intervention.

A combination of persistent inflation and sluggish growth worldwide, plus a U.S. central bank committed to hiking rates aggressively, has turned the greenback into the financial market’s most triumphant winner. The strong dollar is thrashing rival currencies in the process and wreaking havoc around the world. And because the Federal Reserve is not yet done with hiking rates, the dollar — which moves in tandem with where U.S. borrowing costs are likely to go, relative to the rest of the world — has more room to run.

The ICE U.S. Dollar Index DXY, -0.19%, which measures the currency against a basket of six major rivals, is up 23% over the past 12 months and trading at its highest level since around April 2002, despite a 0.3% slip on Thursday that moderated this week’s gains, according to Refinitiv. Its steep climb has captured just about everyone’s attention: More central banks, like Japan’s, are taking actions to bolster their own currencies. Meanwhile, an adviser to U.S. President Joe Biden dismissed the idea of a Plaza Accord-like intervention this week, as did a team at Morgan Stanley.

“Coordinated FX intervention is difficult in the modern era and we doubt it will occur soon. If it did, we doubt under current conditions that it would result in sustained dollar weakness,” according to a Thursday note from economists and strategists at Morgan Stanley. 20-year high A key dollar index is trading at levels last seen in 2002.

Last week’s historic intervention by Japan to prop up the yen for the first time in decades is the main reason why talk of a major intervention on the dollar has picked up, even if the question of whether one will ever happen is still unsettled.

The Plaza Accord refers to the unprecedented, ambitious and far-reaching currency intervention agreement reached by officials from the U.S., Japan, West Germany, France and the U.K. who met at New York’s Plaza Hotel. The goal was to end an unruly rally in the value of the dollar against other major currencies over the first half of the 1980s. It worked, sending the greenback lower throughout the following decade, though not without the nations agreeing to adjust their own economies on a scale that seems almost unimaginable today.

“We forget that the discussions around currency coordination that led to the Plaza Accord arguably started in 1982, which would put the lead time for such an agreement at over three years,” the Morgan Stanley team wrote.

In addition, a weaker dollar would undermine the Federal Reserve’s objective of achieving lower inflation, the team of economists and strategists said, adding that “a weaker dollar is, on net, inflationary in the U.S. and deflationary abroad.” Even if an intervention did take place, it would likely be on the back of more volatile moves in financial markets, they said....


Reagan Approved Plan to Sabotage Soviet Natural Gas Pipeline

 From the Washington Post,

In January 1982, President Ronald Reagan approved a CIA plan to sabotage the economy of the Soviet Union through covert transfers of technology that contained hidden malfunctions, including software that later triggered a huge explosion in a Siberian natural gas pipeline, according to a new memoir by a Reagan White House official.

Thomas C. Reed, a former Air Force secretary who was serving in the National Security Council at the time, describes the episode in "At the Abyss: An Insider's History of the Cold War," to be published next month by Ballantine Books. Reed writes that the pipeline explosion was just one example of "cold-eyed economic warfare" against the Soviet Union that the CIA carried out under Director William J. Casey during the final years of the Cold War.

At the time, the United States was attempting to block Western Europe from importing Soviet natural gas. There were also signs that the Soviets were trying to steal a wide variety of Western technology. Then, a KGB insider revealed the specific shopping list and the CIA slipped the flawed software to the Soviets in a way they would not detect it.

"In order to disrupt the Soviet gas supply, its hard currency earnings from the West, and the internal Russian economy, the pipeline software that was to run the pumps, turbines, and valves was programmed to go haywire, after a decent interval, to reset pump speeds and valve settings to produce pressures far beyond those acceptable to pipeline joints and welds," Reed writes.

"The result was the most monumental non-nuclear explosion and fire ever seen from space," he recalls, adding that U.S. satellites picked up the explosion. Reed said in an interview that the blast occurred in the summer of 1982.

"While there were no physical casualties from the pipeline explosion, there was significant damage to the Soviet economy," he writes. "Its ultimate bankruptcy, not a bloody battle or nuclear exchange, is what brought the Cold War to an end. In time the Soviets came to understand that they had been stealing bogus technology, but now what were they to do? By implication, every cell of the Soviet leviathan might be infected. They had no way of knowing which equipment was sound, which was bogus. All was suspect, which was the intended endgame for the entire operation."

Reed said he obtained CIA approval to publish details about the operation. The CIA learned of the full extent of the KGB's pursuit of Western technology in an intelligence operation known as the Farewell Dossier. Portions of the operation have been disclosed earlier, including in a 1996 paper in Studies in Intelligence, a CIA journal. The paper was written by Gus W. Weiss, an expert on technology and intelligence who was instrumental in devising the plan to send the flawed materials and served with Reed on the National Security Council. Weiss died Nov. 25 at 72.

According to the Weiss article and Reed's book, the Soviet authorities in 1970 set up a new KGB section, known as Directorate T, to plumb Western research and development for badly needed technology. Directorate T's operating arm to steal the technology was known as Line X. Its spies were often sprinkled throughout Soviet delegations to the United States; on one visit to a Boeing plant, "a Soviet guest applied adhesive to his shoes to obtain metal samples," Weiss recalled in his article.

Then, at a July 1981 economic summit in Ottawa, President Francois Mitterrand of France told Reagan that French intelligence had obtained the services of an agent they dubbed "Farewell," Col. Vladimir Vetrov, a 53-year-old engineer who was assigned to evaluate the intelligence collected by Directorate T....


Wednesday, September 28, 2022

Zoltan Pozsar's August 1 Dispatch: "War and Interest Rates"

When we posted on Mr. Pozsar's piece on August 2 we only linked to the Bloomberg story rather than to the original source which is our usual style. Someone (ahem) screwed up. This was our Aug. 2 post:

Zoltan Pozsar Says L-Shaped Recession Is Needed to Conquer Inflation
So 2 1/2% rates and no movement on the Fed balance sheet isn't going to be enough to cut 9.1% inflation?

But for those folks (like ourselves) who prefer to get things without any filters, here is Credit Suisse, August 1, 2022:

War is inflationary.

Wars come in many different shapes and forms. There are hot wars, cold wars, and what Pippa Malmgren calls hot wars in cold places – cyberspace, space, and deep underwater (see here). We would also add to the list of cold places “corridors of power” in Washington, Beijing, and Moscow, where great powers are waging hot wars involving the flow of technologies, goods, and commodities – hot economic wars – which have been major contributors to inflation recently. Inflation did not start with the hot war in Ukraine...

...but the war did fan the inflationary currents that had been under way already: understanding today’s inflation as the result of an escalating economic war and a lingering pandemic is important, for if war and zero-Covid policies stay, the view that inflation is mostly cyclical, driven by excessive stimulus, is wrong.

After visiting over 150 clients in eight European capitals over six weeks, my impression is that the expected path of Western policy rates rests on two hopes: first, that inflation is about to peak; second, that we are near peak hawkishness.

Obviously, if the first view is right, the second view is right too. But the risk with the first view is that it assumes a stable world with no geopolitical risk premia where demand management is more powerful than issues related to supply, when in fact we live in an unstable world where geopolitical risk premia are rising and where supply-side issues are more powerful than demand management.

It follows that if the first view is wrong (inflation is driven by the economic war, not stimulus), the second view is wrong too (we are not at peak hawkishness). The aim of today’s dispatch is to highlight risks to the peak hawkishness view. We won’t be forecasting. We’ll be observing. And you’ll draw your conclusions.

Thus, with slight exaggeration, the low inflation world stood on three pillars: first, cheap immigrant labor keeping service sector wages stagnant in the U.S.; second, cheap goods from China raising living standards amid stagnant wages; third, cheap Russian gas powering German industry and the EU more broadly.

U.S. consumers were soaking up all the cheap stuff the world had to offer: the asset rich, benefiting from decades of QE, bought high-end stuff from Europe produced using cheap Russian gas, and lower-income households bought all the cheap stuff coming from China. All this has worked for decades, until nativism, protectionism, and geopolitics destabilized the low inflation world..

President Trump’s immigration policies to appease nativists has cost the U.S. two million jobs, which is driving the current labor shortages and wage pressures. Covid-19 changed labor markets further: early retirements and other changes have exacerbated the labor shortages and increased wage pressures further.

President Trump’s hardline approach to China became a bipartisan stance that drove the imposition of protectionist tariffs on China, and what started as a trade war became a technology war: the U.S. went from tariffs on cheap goods, to banning ASML from selling state-of-the-art lithography machines to China to ensure the balance of technological power remains in U.S. hands (see here).

President Xi’s zero-Covid policy continues to frustrate the flow of cheap goods, causing occasional cardiac arrests in global supply chains and backlogs at ports; trade and economic relations between the U.S. and China became inflationary, in contrast to previous decades when U.S.-China relations were deflationary...

President Putin’s efforts to make Europe dependent on cheap Russian gas – in order to tip the balance of economic power in Europe away from the U.S. – were frustrated by the U.S. sanctioning Nord Stream 2 last November, and President Putin’s frustration with the shifting balance of military power in Europe (NATO) then spilled over into a hot war in Ukraine on February 24th, which supercharged the economic war. Both sides went “nuclear” quickly, economically: the U.S. weaponized the U.S. dollar, and then Russia weaponized commodities. Welcome to the war economy...

...where heads of state matter more than heads of central banks....


If compared with his August 24 piece which we re-read yesterday there is a distinct change in tone, he is not nearly as 'blamey' in the latter and actually seems as though he would agree with President Trump on not sending the most advanced chip making equipment to China. 

On the immigration issue, in the first eighteen months of President Biden's first term more than 4.8 million immigrants have crossed the U.S. - Mexican border with no appreciable effect on labor bottlenecks.

There is a huge skills mismatch between what those 4.8 million people can do upon their crossing onto U.S. soil and what the U.S. economy requires that neither Zoltan nor the Business Insider piece he links to even mentions.

For the rest, the overriding point is the one that got me Re-reading Zoltan Pozsar's August 24th Missive, "War and Industrial Policy", wars are paid for one way or another, through debt, through taxes but most often, throughout history, through inflation.

UPDATE—Death Toll From New, Very Unusual, Ebola Strain Now At 23 People

Following up on September 20's "Rare Ebola outbreak declared in Uganda". 

From Ars Technica, September 27:

Unusual Ebola strain kills 23 in Uganda; no vaccines, treatments available
The Sudan species of Ebolavirus has a fatality rate between 41% and 100%.

Health officials in Uganda are scrambling to catch up to a burgeoning Ebola outbreak caused by a lesser-seen Ebolavirus species called Sudan virus (SUDV), for which there is no vaccine or treatment.

Information so far suggests that the outbreak response efforts may be three weeks behind the initial spread of SUDV, which has an incubation period of up to 21 days and a case fatality rate between 41 percent and 100 percent. So far, 36 cases (18 confirmed, 18 probable) have been identified, with 23 deaths. Health officials have listed a total of 223 contacts.

But that number is likely an undercount. Several transmission chains have not been tracked, and some health facilities that saw Ebola patients did not follow optimal infection control measures, the World Health Organization warned. Further, because of the delayed recognition of the outbreak, some patients were buried in traditional ceremonies with large gatherings that could have allowed the virus to transmit further....


Copper: I Hate The Bank Of England

 And not simply for the whack to the GBP/Honduran lempira pair.

No, the BoE deciding to restart QE gives hope to every damn punk who has only known moneyprinting liquidity for their entire trading career, they see the Old Lady reverse course and think "Hey, the Fed will do that too!", so they sell the dollar, buy treasuries (blowing out the negative 10-year yield once more) and hammer copper for almost a dime in the wrong direction.

Every goddam time.

Futures $3.3815 up 0.0980.

At least I still have my proto-NFT CryptoKitties.

Uhhh, sir:

Here's ZeroHedge with the gory details of the day's action:


'effin CryptoKitties, ethereums's killer app my ass.

Reinsurance/Catastrophe Bonds: "Hurricane Ian—Sustained winds intensify to 155mph, as scenario worsens"

From Artemis:

The major hurricane Ian landfall scenario has worsened considerably after the NHC found the storm has intensified rapidly again, to now pack 155 mph sustained winds as a high-end Category 4 storm on approach to Florida.

We are now looking at a hurricane landfall with strong Category 4 sustained wind speeds it seems, with some additional strengthening even possible and Category 5 not out of the question now.

Hurricane Ian has deepened considerably, as we suggested was possible earlier today, with the minimum central pressure now stated at 937 mb.

Some meteorologists are now saying a little additional deepening is possible as hurricane Ian approaches land, while at the same time the wind field is set to expand, some forecasters say.

This threatens a wider area of stronger and more intense winds, with the potential for more property damage and higher, more impactful storm surge, than modelled scenarios put out yesterday or first thing this morning had considered possible.

The storm surge forecasts have been increased, with now up to 18 foot of surge said possible.

The NHC now states that “Ian is forecast to make landfall on the west coast of Florida as a catastrophic category 4 hurricane” and predicts “Catastrophic storm surge, winds and flooding” for the Florida Peninsula, highlighting it as “a life-threatening situation.”

Does this mean loss estimates could rise? It’s entirely possible, although a range of up to $40 billion still seems most likely, more on that in our earlier article.

One thing is certain, hurricane Ian is looking more dangerous by the hour as it approaches Florida, with a significant threat to lives and property unfolding.

The industry loss quantum will come down to specific landfall location, region most affected by the highest winds, and also how long hurricane force gusts are sustained across the Florida Peninsula.

The NHC cone data still shows a 140 mph hurricane right up to landfall, after which it is expected to weaken to Cat 1 as it crosses Florida.

The risk of hurricane Ian becoming an Atlantic landfall event also remains.

It’s of note that one of the models, the German Icon, showed a resurgent hurricane Ian moving across Florida, into the Atlantic to strengthen and come ashore around Charleston on the east SC coast. That’s a scenario nobody would want to see unfold, but a number of models now take hurricane Ian across the Florida Peninsula and back into the Atlantic (including the NHC cone), so can’t be completely ruled out and is something to watch for.....


Also at Artemis:
Hurricane Ian: Track slips south, to grow & slow, loss estimates range up to $40bn

The 7 am EDT NHC advisory warns of  storm surge inundation of 12 to 16 feet above ground level.

As Great Britain's Pound Collapses Versus The Original Banana Republic's Currency, The Honduran Lempira, The World Asks.... (GBPHNL)

From TradingView:

TradingView Chart

From the pound's recent high on January 14 to today's latest print the exchange rate has gone from requiring 33.56 Lempiras to buy a pound to only requiring 26.232 HNL i.e. 21.83% fewer, will City bankers be able to afford to put a banana in their pockets?

This Might Be Very Important: Health and Wellness For Laptop Warriors

From the University of Houston (and published at Elsevier's iScience, September 16):

Discovery Unlocks Potential of 'Special' Muscle
'Soleus Pushup' Fuels Metabolism for Hours While Sitting

From the same mind whose research propelled the notion that “sitting too much is not the same as exercising too little,” comes a groundbreaking discovery set to turn a sedentary lifestyle on its ear: The soleus muscle in the calf, though only 1% of your body weight, can do big things to improve the metabolic health in the rest of your body if activated correctly.

And Marc Hamilton, professor of Health and Human Performance at the University of Houston, has discovered such an approach for optimal activation – he’s pioneering the “soleus pushup” (SPU) which effectively elevates muscle metabolism for hours, even while sitting. The soleus, one of 600 muscles in the human body, is a posterior leg muscle that runs from just below the knee to the heel.

Published in the journal iScience, Hamilton’s research suggests the soleus pushup’s ability to sustain an elevated oxidative metabolism to improve the regulation of blood glucose is more effective than any popular methods currently touted as a solution including exercise, weight loss and intermittent fasting. Oxidative metabolism is the process by which oxygen is used to burn metabolites like blood glucose or fats, but it depends, in part, on the immediate energy needs of the muscle when it’s working.

“We never dreamed that this muscle has this type of capacity. It's been inside our bodies all along, but no one ever investigated how to use it to optimize our health, until now,” said Hamilton. “When activated correctly, the soleus muscle can raise local oxidative metabolism to high levels for hours, not just minutes, and does so by using a different fuel mixture.”

Muscle biopsies revealed there was minimal glycogen contribution to fueling the soleus. Instead of breaking down glycogen, the soleus can use other types of fuels such as blood glucose and fats. Glycogen is normally the predominant type of carbohydrate that fuels muscular exercise.

“The soleus’ lower-than-normal reliance on glycogen helps it work for hours effortlessly without fatiguing during this type of muscle activity, because there is a definite limit to muscular endurance caused by glycogen depletion,” he added. “As far as we know, this is the first concerted effort to develop a specialized type of contractile activity centered around optimizing human metabolic processes.”

When the SPU was tested, the whole-body effects on blood chemistry included a 52% improvement in the excursion of blood glucose (sugar) and 60% less insulin requirement over three hours after ingesting a glucose drink.

The new approach of keeping the soleus muscle metabolism humming is also effective at doubling the normal rate of fat metabolism in the fasting period between meals, reducing the levels of fat in the blood (VLDL triglyceride).

The Soleus Pushup
Building on years of research, Hamilton and his colleagues developed the soleus pushup, which activates the soleus muscle differently than when standing or walking. The SPU targets the soleus to increase oxygen consumption – more than what’s possible with these other types of soleus activities, while also being resistant to fatigue.

So, how do you perform a soleus pushup?.....


Again, the paper itself via the U.S. National Institutes of Health, National Library of Medicine:

A potent physiological method to magnify and sustain soleus oxidative metabolism improves glucose and lipid regulation

Tuesday, September 27, 2022

Re-reading Zoltan Pozsar's August 24th Missive, "War and Industrial Policy"

We posted the front page of the 10-page PDF but something Izabella Kaminska wrote at The Blind Spot about war and financing same reminded me of something Zoltan Pozsar posited.

From Credit Suisse, August 24, 2022:

Page 7:

....I get it why the U.S. wants to invert time. But we can’t win by slowing progress.
We’ll also have to progress by building, and that’s where industrial policy comes in:

as an investor, you care about the inflationary consequences of Russia and China
challenging the U.S. hegemon. Where inflation goes, policy rates go, or if not,
financial repression is an issue. Either way, you care, especially if you are a
bond house or if you depend on fixed income. These are the scary times when
the “euthanasia of the rentier” is a risk. To ensure that the West wins the

economic war
to overcome the risks posed by our commodities, your problem”;
chips from our backyard, your problem”; and “our straits, your problem
the West will have to pour trillions into four types of projects starting yesterday:

(1) re-arm (to defend the world order)
(2) re-shore (to get around blockades)
(3) re-stock and invest (commodities)
(4) re-wire the grid (energy transition)

Similar to how Basel III was the tab associated with the Great Financial Crisis,
the above list is the tab for the currently unfolding Great Crisis of Globalization”.
The four items on the list are self-explanatory. We read about them every day:

Regarding re-arming, Germany plans to spend $100 billion on arms (see
the West plans to spend some $750 billion to re-build Ukraine (see
here), and
the G7 aims to raise $600 billion to counter China’s Belt and Road (see
yes, the game of chess in Eurasia is also about the Belt and Road Initiative...

Regarding re-shoring, Secretary Raimondo’s focus on chips for the military and
the three new fabs funded by the $52 billion CHIPS Act is just the beginning.
The EU is also busy funding fabs to regain industrial sovereignty (see
Supply chain issues due to zero-Covid policies will bring home more industries.
Friend-shoring won’t work, as stuff from friends will have to sail through straits,
and what’s the point of friend-shoring if straits can be subject to blockades?

Regarding re-stocking, news of the EU’s natural gas and electricity shortages
need no belaboring: the EU needs to re-stock to keep industry alive and to heat.
The U.S. will also have to re-stock: the SPR will be “empty” by November.
India has instructed all its industrial states to build inventories of coal sufficient
to cover residential and industrial needs for the next three years (see
Europe and China are suffering historic droughts at the moment, and this year’s
wheat harvest in Ukraine is missing. Food and energy shortages are looming...

...and commodity inventories will take off like FX reserves after the 1997 crisis,
and will involve not just food and energy but also some industrial commodities.

Regarding re-wiring the grid, governments commitment remains unwavering,
even after the war in Ukraine. Energy transition was the only big item on the
to-do-list before the war and was a formidable economic challenge to begin with.
After the war, the list got longer and so the challenge became even more formidable.

I think that the above four themes (re-arm, re-shore, re-stock, and re-wire
the electric grid) will be the defining aims of industrial policy over the next five years.
How much the G7 will spend on these items is an open question, but given that
the global order is at stake, they will likely not be penny pinching. If Tim Geithner
were in charge, he’d put a lot of money in the window to show who’s in charge.

And hopefully it will be like that...

...and if so, any investor will have to be mindful that the above to-do-list is:

(1) commodity intensive
(2) capital intensive
(3) interest rate insensitive
(4) uninvestable for the East

Commodity intensity means that inflation will be a nagging problem as the West
executes on the above list. Re-arming, re-shoring, re-stocking, and re-wiring
need a lot of commodities it’s a demand shock. It’s a demand shock in a
macro environment in which the commodities sector is woefully underinvested
a legacy of a decade of ESG policies. Underinvestment means supply constraints,
and geopolitics means even more supply constraints: resource nationalism
see Russia’s stance or Mexico’s recent decision to
nationalize lithium mines
means that the supply you think is there to meet the surge in demand isn’t there:
prices can thus surge. Executing on the to-do-list can easily drive another
commodity super cycle, like the one we had after China joined the WTO in 2000.
But that super cycle happened in the context of a peaceful, unipolar world order
in which great powers had positive expectations of the future trade environment
(see the “theory of trade expectations” above). But thats not the case anymore.

Capital intensity means that governments and also the private sector will have
to borrow long-term to execute the to-dos. Re-arming and re-stocking are the
domains of the government, and re-shoring and re-wiring the grid will involve
public-private partnerships. Private firms will have to issue debt and raise equity
to build things: ships, F-35s, factories, commodity warehouses, and wind turbines.

Insensitivity to interest rates means that the to-do-list will have to be executed
regardless of whether the Fed hikes rates to 3.5% or 7%. Hell or high water,
executing on the to-do-list is imperative. Industrial sovereignty depends on it.

On the other hand, private equity is sensitive to interest rates, and industrial policy
done right, with overwhelming force, will eventually crowd out private equity.
Finance is about multi-decade cycles. Private equity rode the “lowflation” cycle
and the cycle of globalization that, post-GFC, enabled decades of money printing.....


As Ms. Kaminska says, one way or another wars are paid for.

And at The Blind Spot