Why stock exchanges around the world are going down and what can happen to our money

Global financial markets are experiencing the worst period since the 2008 financial crisis. With inflation persisting, they continue to discount the prospect of further interest rate hikes. The American 10-year hit a 4% yield in the past week, the highest level since 2010.

The US dollar continues to appreciate against other currencies. This is partly due to the Federal Reserve, which is raising interest rates to cope with inflation that is wearing down the American citizen and saver. And it is moving much faster than other central banks around the world to tackle the same problems, in part because investors are shedding riskier assets to buy US dollar-denominated ones, which are considered much safer (” safe asset “).

Although the United States is the country with the most restrictive monetary policies, these policies produce their most disruptive effects in the rest of the world: since most commodities are priced in dollars, Countries considered to be net importers of energy and raw materials (including the European Union) undergo an increase in priceswhich are already high, due to the disadvantageous exchange rate.

Among the currencies that are reporting the worst performance against the US dollar there is certainly the British pound, which, given the events of the last week, deserves a separate mention. Following the announcement (later withdrawn) of a maxi-tax cut financed entirely with public deficit, investors began to sell British government bonds en masse, causing a sudden rise in interest rates, resulting in a collapse in the price. of such securities.

The key role was played by the so-called LDI pension funds (Liability Driven Investing): these are funds that equalize the fruits of investments with future liabilities from the point of view of the fund itself (pensions). In this way, these funds take on the investment risk in order to guarantee retirees a guaranteed future income independent of market fluctuations. They manage to do this by subscribing to government bonds with a maturity equal to the flow of pensions to be paid, the amount of which is pre-established at the beginning of the relationship between the fund and the employee.

Over time, however, to guarantee these returns, LDI funds have also begun to use particularly sophisticated derivative instruments such as interest rate swap, which are subscribed with a counterparty that pays a yield previously set against the payment of a margin upon signing the swap and the additional payments that the fund will pay depending on the fluctuation of the yields: if the yields rise, the pension fund will have to pay the counterparty; if they go down, the counterparty will pay the fund.

Due to the sudden rise in yields, mostly due to the Truss government plan, pension funds have had to pay increasing amounts of money. This forced them to sell government bonds, further depressing their price and increasing their yields. The Bank of England therefore had to intervene to flatten the yield curve, launching a plan to purchase government bonds worth £ 65 billion in two weeks.

What we witnessed in the UK therefore served as proof of how dangerous it is to finance public deficit spending at a time when central banks are trying to bring inflation under control with interest rate hikes. If fiscal leverage is used at a time when monetary leverage goes in the opposite direction, it can happen that economic agents doubt the sustainability of a country’s public budget, with heavy risks for citizens – not just the UK, as pension funds around the world have government bonds issued by countries around the world in their portfolios.