“Excuse me sir, do you speak English?” I asked. “Yes,” he said. “Is this the correct track for the train to Zurich,” I continued. “Yes,” he replied, a friendly nod. “Perfect, so then I will be taking the only Swiss train on the planet that is running late today,” I said, smiling, the large display in St. Gallen showing just one delay amongst fifteen or so trains. “Ah, yes, indeed, this would be precisely right,” he said, shaking a finger in the air, erupting with an excessive enthusiasm, like I had given this stranger the most extraordinary gift of his sixty-plus years on earth. “Except that this train originated in Munich and is operated by the Germans!”

Overall: “If the territorial integrity of our country is threatened, we will without doubt use all available means to protect Russia and our people,” declared Vladimir Putin, calling 300,000 reservists to join his tragic war, while implicitly threatening to tap his nuclear stockpile. “This is not a bluff,” warned the dictator, widening the range of possible outcomes we face this decade. Should Putin suffer total defeat, it could open an era of great prosperity for Europe, Russia, its satellites. Or perhaps it would invite mayhem. What will follow the collapse of Putin’s rule could take many directions. And at the other end of the spectrum, if a desperate Vladimir were to start a nuclear war, Rutgers University estimates famine would kill two-thirds of humanity. “It is in our historical tradition, in the fate of our people, to stop those striving for world domination, who threaten the dismemberment and enslavement of our Motherland, our Fatherland,” explained Putin, addressing the Russian people, “We will do it now, and it will be so.” A great-power war, of course, is by far our greatest known threat. The risks we face from decades of monetary mischief pale in comparison, but they have begun to manifest. “We have taken decisive action,” declared Masato Kanda, describing Japan’s latest circular reference; a policy to buy yen, while printing yen, to buy bonds, while issuing them. Such a preposterously unsustainable policy is only possible in those nations which have built large reserves, and Japan amassed $1.3trln worth. As it draws those down, it’ll sell overseas assets, and in anticipation, US government bond prices hit new lows. In a desperate attempt to rescue its economy from the stagflationary malaise sweeping the planet, the UK’s new government announced massive fuel subsidies and tax cuts. The pound and gilts collapsed, as if the UK were an emerging market. This is what happens when nations deplete their reserves, and the British appear to have no policy credibility left in store. This will force the Bank of England to hike interest rates, sharply, into recession, like they did in 1992. 

One River Digital’s Deputy CIO, Marcel Kasumovich, published the following note on a tool we developed called Macro Pulse. It turns the ISM survey of manufacturing business conditions into states of the economic cycle, ranging from growth boom to bust. It provides an effective risk management tool for asset allocation and can enhance digital asset management [click here].

Week-in-Review (expressed in YoY terms): Mon: UK / Japan holiday, Zelensky claims discoveries of Russian atrocities in recently recaptured territory, Biden says US will come to defense of Taiwan if China invades, Chengdu lockdown ends, PBOC sets yuan fix at strongest bias on record, Japan’s cabinet approval drops to 29% - worst Kishida has seen, final polls in Italy show comfortable 20pt lead for centre-right coalition, US NAHB housing mkt index 46 (47e), S&P +0.7%; Tue: Riksbank surprises with 100bp hike (75bp exp), RBA mins reiterated slower pace of future hikes, PBOC kept 1y & 5y LPR unch as exp, Ford falls after warning on higher supply costs, Germany closes in on deal to nationalize gas giant Uniper, NATO/UN slam “sham” referendums in occupied parts of Ukraine that Russia has scheduled for later in the week, US/Canadian ships sail through Taiwan strait, Russian oil expts fell below 3m bpd for first time in 5m, Japan CPI 3% (2.9%e) / Core CPI 1.6% (1.5%e), Germany PPI 45.8% (36.8%e), EU Current Account weakest since GFC -19.9b (4.2b prev), US housing starts 1.575m (1.45m exp) / building permits 1.517m (1.604m exp), Canada CPI 7% (7.3%e) / Trimmed CPI 5.2% (5.5%e), S&P -1.1%; Wed: Fed hikes 75bps as exp / DOT plot revised upward (hawkish) – 75 & 50 at next two meetings/ economic forecasts show rising unemp to bring down infl / Powell highlights “main message has not changed since JH”, BCB unch as exp / strikes a hawkish tone, Putin holds first nat’l address since Ukraine invasion and announces “partial mobilization” – calls up 300k reservists / hints at nuclear threats, BOJ does unscheduled bond buying of 5-10y and 10-25y bonds on top of standing unlimited purchase of 10y JGBs, Trump sued by NY attorney general for fraudulently overvaluing his assets, UK Public borrowing 11.8b (8b exp), US existing home sales -0.4% MoM (-2.3%e), Russia PPI 3.8% (4%e), S&P -1.7%; Thur: BOJ unch as exp / Kuroda says could be no need to change guidance for 2-3y / 1hr after BOJ decision the MOF conducted FX intervention to buy JPY, BoE hikes 50bp (75bp exp) / 3 votes for 75bp vs 1 for 25bp, SNB hikes 75bp as exp, Norges bank hikes 50bp as exp, S. Africa hikes 75bp as exp, Taiwan CB hikes 12.5bp as exp, Indonesia CB hikes 50bp (only 25bp exp), Philippines CB hike 50bp as exp, Turkey CB CUTS 100bp (unch was exp), HK to end mandatory hotel quarantines, Medvedev says Russia’s new territory could be defend with nukes, Japan’s Kanda says they could conduct “stealth intervention”, US mortgage rates jump to 6.29% - highest since 2008, France business conf 102 as exp, US CA balance -251.1b Q2 (-260b exp), US init claims 213k (217k exp), US leading index -0.3% MoM (-0.1%e), EU cons conf -28.8 (-25.5e), US KC Fed 1 (5 exp), S&P -0.8%; Fri: UK new gov’t unveils enormous tax cut package (largest since 1972) – Gilts/GBP collapse, Japan announces end to Covid restrictions / open the door back to mass tourism, large number of men fleeing Russia to avoid conscription as mobilization rumored to be much larger than announced 300k, voting begins in 4 occupied territories in Ukraine on whether to join Russia, UK cons conf -49 (-42e), EU flash PMIs mfg 48.5 (48.8e) / serv 48.9 (49.1e) / comp 48.2 as exp, UK flash PMIs mfg 48.5 (47.5e) / serv 49.2 (50e) / comp 48.4 (49e), US flash PMIs mfg 51.8 (51e) / serv 49.2 (45.5e) / comp 49.3 (46.1e), S&P -1.7%; Sun: Italian elections (Giorgia Meloni's far-right Brothers of Italy expected to win).

Weekly Close: S&P 500 -4.6% and VIX +3.62 at +29.92. Nikkei -1.5%, Shanghai -1.2%, Euro Stoxx -4.4%, Bovespa +2.2%, MSCI World -3.1%, and MSCI Emerging -2.3%. USD rose +13.1% vs Ethereum, +5.6% vs Bitcoin, +5.2% vs Sweden, +5.2% vs Sterling, +5.1% vs Chile, +3.4% vs Euro, +2.9% vs Australia, +2.5% vs Canada, +2.0% vs China, +1.9% vs South Africa, +1.6% vs India, +0.9% vs Mexico, +0.9% vs Turkey, +0.6% vs Indonesia, +0.3% vs Yen, +0.2% vs Brazil. Gold -1.7%, Silver -2.4%, Oil -7.1%, Copper -4.9%, Iron Ore -2.0%, Corn -0.1%. 5y5y inflation swaps (EU flat at 2.22%, US -2bps at 2.48%, JP -9bps at 0.88%, and UK -4bps at 3.76%). 2yr Notes +34bps at 4.21% and 10yr Notes +24bps at 3.69%.

YTD Equity Indexes (high-to-low): Turkey +27% priced in US dollars (+76.7% priced in lira), Argentina +20.9% priced in US dollars (+71.2% priced in pesos), UAE +18.1% priced in dollars (+18.1% in dirham), Brazil +13.2% in dollars (+6.6% in reais), Chile +6.4% (+20.9%), Indonesia +3% (+9.1%), Saudi Arabia +1.4% (+1.6%), Singapore -2.6% (+3.3%), India -8.3% (-0.2%), Portugal -11% (+4.4%), Thailand -12.7% (-1.6%), Mexico -13.7% (-14.8%), Israel -14.5% (-4.3%), Venezuela -15.2% (+48.9%), Malaysia -17.4% (-9.1%), Canada -18.9% (-12.9%), Norway -20.2% (-4%), Australia -20.6% (-11.7%), S&P 500 -22.5%, MSCI World -23% priced in dollars, UK -23.5% (-5%), Japan -23.7% (-5.7%), Philippines -23.7% (-12.1%), Greece -23.8% (-10.7%), HK -23.9% (-23.4%), China -24.3% (-15.1%), South Africa -24.5% (-14.8%), Colombia -25.1% (-18%), Russell -25.2%, Spain -25.3% (-13%), New Zealand -26.3% (-12.3%), Switzerland -26.6% (-21.3%), Russia -28.6% (-44.8%), Czech Republic -29% (-18.1%), Denmark -29.6% (-18%), NASDAQ -30.5%, France -31.1% (-19.1%), Netherlands -31.7% (-19.9%), Belgium -32.3% (-20.6%), Taiwan -32.4% (-22.5%), Finland -33.5% (-22.5%), Euro Stoxx 50 -33.6% (-22.1%), Germany -33.7% (-22.7%), Italy -33.9% (-23%), Ireland -34.9% (-23.7%), Korea -35.5% (-23.1%), Austria -39.3% (-29.3%), Sweden -39.7% (-24.9%), Hungary -40.7% (-23.8%), Poland -42.5% (-30.6%).

Silent But Deadly: “The Fed rate hiking cycle has been fast - over the past five cycles, only 1988 was faster and only 2004 of greater magnitude,” said Marcel Kasumovich, One River Digital’s Deputy CIO, and our industry’s master market plumber. “That covers the saving-and-loan crisis, Asia crisis, Russia’s default, the tech boom-bust, housing crisis, and the last rate normalization. It’s not Volcker but feels similar - the yield curve is as inverted as then, housing affordability for first-time buyers is as bad, and consumers feel like rates are at 1982 levels judging by confidence surveys. Rate hikes are obvious, but today’s tightening in liquidity conditions is much less so.”

Silent But Deadly II: “The contraction in central bank balance sheets is silent tightening,” continued Marcel, seriously nerding out, something I secretly love. “It is important to reflect on how we got here. The policy narrative is that ‘balance sheet policies were employed to support the economy during a time of exceptional stress in financial markets,’ NY Fed Zobel observed in an excellent speech. The data read differently. Excess reserves, the policy tool used during QE and QT, rose $1,072bln in the chronic phase of the pandemic’s economic downturn. In the months following, reserves increased another $1,589bln, 1.5-times the gain during the period of greatest stress.”

Silent But Deadly III: “Breaking up with QE is hard to do. And it is being done at breakneck speed. Reserves have declined $1,270bln from their Dec peak. It took more than 3yrs in the previous QT to generate a similar contraction. But didn’t QT just start? Indeed. On the asset side of the Fed balance sheet, Treasury securities and mortgages have only declined by $113bln. Planned asset reductions were accelerated in Sept, to a monthly rate of $95bln. This is wholly divorced from the rapid tightening implied by reserves. Why the difference?”

Silent But Deadly IV: “This time is different, every time is. There’s a new QT sheriff in town, and it is reserve repo agreements (RRPs). Zobel emphasizes that the ‘RRP facility's expansion broadened the base of Federal Reserve liability holders beyond the banking system.’ RRPs are a liability to the Fed. When they go up, reserves go down. There are 133 counterparties to RRPs - 103 of them are money market funds. Fidelity alone has 11. And RRPs have been very popular with the rise in short rates. The facility has increased to a record $2,315bln, counter to the policy expectation.”

Silent But Deadly V: “The RRP rate moves mechanically with policy. On last week’s 75bps rate increase, the RRP rate rose from 2.30% to 3.05%. There is no bid/offer, only a quantity limit by counterparty - no more than $160bln, please. So why the demand? Well, as of Fri Sept 23, 2022, the standard rate on a JPM saving deposit was 0.01%. The relationship rate for a balance of more than $25k was double the standard, at 0.02%. The usage of RRPs is supposed to be limited by private competition for short term funding. But this is the first cycle where we have seen the tool in action. And it isn’t happening, funds are instead flowing to RRPs, overwhelmingly, in massive size, speed.”.

Silent But Deadly VI: “The steep inversion of the real yield curve and deflation across financial assets, commodity markets, and housing have greatly elevated demand for cash. Whereas longer duration bonds typically provide cushion when risks emerge, Treasury bonds have cratered in value reinforcing the propensity for investors to move to cash. RRPs are their vehicle of choice. What level of ‘ample reserves’ is appropriate for the banking system? In the last cycle it was $1.50-$1.75trln. The cushion is almost surely greater now. And we’re falling to this level a lot faster than last time. We could be only weeks away. QT is accelerating into it.”

Silent But Deadly VII: “A narrow liquidity crunch is not the issue. Central banks can trivially target higher reserves and focus on interest-rate targeting as they did in 2019 to alleviate the stress that is building. (Just don’t call it QE.) Technical measures like increased T-bill issuance can alleviate pressures. But the point is bigger, broader. Investor portfolios have been calibrated to a world where the asymmetry of inflation, and of policy rates, were definitively to the downside. And the Fed is now severely constrained when responding to crisis with longer-term inflation risks to the upside. The ‘Fed Put’ isn’t dead – but it is much deeper out of the money.”

Anecdote: “Can we step into an office,” asked the older man, quietly. I was a child, twenty-six, and knew nothing, a blessing. They smoked on the trading floor back then, Lehman, London, 1992. He led me to an unoccupied glass box, closed the door. “I have a problem and need to ask you for help,” he said, unable to make eye contact. He was crying. I was confused and said nothing at first. He was a market-maker and traded foreign-exchange forwards, which we used to speculate on the direction of European interest rates. Their violent moves had only just started, and in general, older traders struggled to adapt to that period of quantum change. They saw continued volatility as an impossibility, failing to recognize the opportunity. Europe’s Exchange Rate Mechanism (ERM) was introduced in 1979 by well-intended bureaucrats who sought economic stability. In the end, it produced the opposite. “Can we please cancel the trade from earlier? I need to cancel that trade. I didn’t hedge it, idiotic, I know. I’ll lose my job. I have a family,” he pleaded. The ERM was designed to promote mean-reversion. When exchange rates drifted from target levels, central banks intervened to reverse their direction. By 1992, the resulting imbalances were extraordinary. Stresses intensified. To maintain stability, central banks resorted to wild interventions. Sweden’s central bank hiked overnight interest rates to 75% in September 1992. The next week it hiked rates to 500%. Three days later it cut them to 50%, then 24%, then 11%. “Of course, you can cancel it,” I said, torn, upset that his catastrophic loss was my forfeited profit. Over the next few years more crises erupted, each unfolded in a novel way, emerging from what had once been considered an impossibility. I saw more older men cry. Each time, their mental anchoring to a past that no longer was, blinded them to an utterly foreign present, its risks, opportunities. And I promised myself to never become such a man.

Good luck out there,

Eric Peters

Chief Investment Officer

One River Asset Management

Disclaimer: All characters and events contained herein are entirely fictional. Even those things that appear based on real people and actual events are products of the author’s imagination. Any similarity is merely coincidental. The numbers are unreliable. The statistics too. Consequently, this message does not contain any investment recommendation, advice, or solicitation of any sort for any product, fund or service. The views expressed are strictly those of the author, even if often times they are not actually views held by the author, or directly contradict those views genuinely held by the author. And the views may certainly differ from those of any firm or person that the author may advise, converse with, or otherwise be associated with. Lastly, any inappropriate language, innuendo or dark humor contained herein is not specifically intended to offend the reader. And besides, nothing could possibly be more offensive than the real-life actions of the inept policy makers, corrupt elected leaders and short, paranoid dictators who infest our little planet. Yet we suffer their indignities every day. Oh yeah, past performance is not indicative of future returns.