| If a government runs a fiscal deficit then to balance their books they need to borrow additional funds from the market. If your fiscal plan doesn't make sense market lenders may not be willing to lend to you or will at least expect a higher interest rate to compensate for their risks. The Conservative party in the UK has just elected a new PM who has announced a fiscal plan which doesn't add up - tax cuts financed with borrowing. Worse still the PM is doing this in an effort to boost growth which only adds to current inflationary pressures at a time where inflation is far too high. Given this the market now believes the central bank will need to be much more aggressive in their fight against inflation and raise their base rate much higher. In addition to this the market is also sceptical of the governments fiscal policy and is demanding a higher risk-premium to lend money. The result is sky rocketing borrowing costs for UK consumers, businesses and the UK government. Pension funds are one of the largest holders of government bonds as they're typically seen as very safe investments (especially within developed markets). But of course every investment still has risks and when those risks are underestimated it can leave a lot of investors on the wrong side of the trade very quickly. As large holders of government bonds many pension funds found themselves in this position and my understanding is that some have been on the verge of blowing up in recent days. Obviously were pension funds to blow up on mass this would have all kinds of negative knock-on effects for the economy. It would also mean many of these funds would become forced sellers of bonds and this forced selling would have added even more volatility and instability to an already volatile market. Basically the UK was at risk of at risk of a GFC style blow-up so to restore stability the BoE was forced to step in yesterday to buy bonds that no one in the market wants to own right now. Interestingly today the PM is doubling down on her fiscal policy. But then she has some fairly controversial economic views, including the belief that higher interest rates is a good thing. In my opinion she's too naive and ideologically driven to understand what she's doing. At the end of the day the BoE can't make a broken fiscal policy work, they can only buy time. If the government doesn't reverse course the UK economy is probably going to implode, but as I say we have a PM so ideologically driven that she may actually see this as a good thing - it's just free-market capitalism cleaning out the weak-hands, etc. Although it's probably electoral suicide my guess is the Conservative party will need to step in at some point and force her to back down in one way or another. If they don't it's hard to see the public will forgive them for this anytime soon. Especially considering many vote for the Conservative party because they're seen as the party of fiscal responsibility. Either way as a mortgage holder who's probably going to default on their mortgage due to all of this I don't expect anyone to step in and help me =) This is my mistake, not the governments. And I'm just a pleb with a family, not a pension fund. |
As the Fed raises rates in the US it makes the dollar a more attractive place to put money. This devalues other currencies against the dollar.
Because the dollar is the reserve currency a lot of stuff countries like the UK imports is denominated in dollars (oil, food, etc). This means the US actually increases inflation pressures for other countries when they raise their domestic interest rates.
This forces other central banks to raise interest rates in line with the US simply to protect their currencies from the inflationary effects of currency devaluation.
Unfortunately right now Europe can't really afford to do this with an ongoing energy crisis, but we have no choice. The US is literally whacking their allies around the head with the US dollar.
But then from the US perspective what choice do they have? The Fed already has little credibility and to allow inflation to run hot in the US to protect Europe from currency devaluation would be equally risky and unpopular.
We're in very tricky times. We've kicked the can down the road for so long that it's now catching up. We no longer have any good options left. It's all just trade-offs from here.
Many including myself did try to warn this was always the risk of such a reckless response to Covid, but I suppose it's too late for that now.