Admiral Lord Horatio Nelson is credited with proclaiming “I see no ships” when disregarding the signal to retreat during the Battle of Copenhagen in 1801. The saying has become a British idiom for somebody ignoring that which they don’t want to see. The story goes that Lord Nelson held his telescope up to his blind eye.
Our minds drifted to this pithy little phrase as we listened to the opening speech at the annual ECB Forum in Sintra, Portugal, from ECB President Christine Lagarde. President Lagarde took the opportunity of the conference, and her slot as the opening speaker, to update on the ECB’s freshly completed “assessment” (she stressed it was an assessment, not a review) of their monetary policy strategy.
“…we saw no need to revisit the key pillars of our strategy. Which is why we refer to the exercise we have just concluded as a strategy assessment rather than a full review.” Christine Lagarde, Sintra 2025.
The last time the ECB updated the monetary policy framework was in summer of 2021. This was when, like the Fed’s Flexible Average Inflation Targeting, the ECB created their symmetrical view around the 2% target, as opposed to the previous “below 2% but close to 2%”, thus intentionally opening greater flexibility to the upside.
Figure 1: Eurozone HICP Index 1990-June2025. 2021 Review (white vertical) and 2025 Assessment (red vertical)
Source: Bloomberg, Convex Strategies
ECB Forum on Central Banking 2025 – Introductory speech
Ms. Lagarde gave her now traditional rundown of all the external shocks that were responsible for the unprecedented overshoot of their price stability mandate.
“Soon after that review, guess what? The world changed in ways that we had not foreseen. The reopening of our economies after the pandemic brought about major sectoral changes. Russia’s unjustifiable and horrible invasion of Ukraine triggered a fundamental shift in energy markets. The geopolitical landscape was upended reshaping global trade. Structural changes in labour markets became increasing apparent driven by demographics, technological transformation, and evolving worker’s preference.” Christine Lagarde. Sintra 2025.
Things that Ms. Lagarde did not touch upon, nor seemingly the 400+ economists across the Eurosystem that she praised for their work on the assessment, as impacting the overshoot would include ZIRP, NIRP, QE, and the change to the symmetric target on either side of 2%. This is all but tradition now with central bankers. Their efforts, from 2008 through 2021 and well into 2022, to reignite inflation, had nothing to do with the subsequent reignition of inflation.
Figure 2: Eurozone HICP yoy% (white). ECB Deposit Rate (blue). ECB Assets (papaya, left scale). 2000-June2025. 2021 Review (white vertical). 2025 Assessment (red vertical)
Source: Bloomberg, Convex Strategies
This is a very common speech-form, particularly amongst central bankers. Avoid accountability while putting the blame on unforeseen exogenous events. Still, one of our favourite versions comes from the incorrigible Jake Blues, explaining to his jilted bride why he left her standing at the altar.
“I ran out of gas. I had a flat tire. I didn’t have enough money for cab fare. My tux didn’t come back from the cleaners. An old friend came in from out of town. Someone stole my car. There was an earthquake. A terrible flood. Locusts. It wasn’t my fault!” Jake Blues, 1980.
The Blues Brothers – Jake’s Excuses
Ms. Lagarde goes on to lay out the key conclusions from their year-long assessment.
- “The world ahead is more uncertain and that uncertainty is likely to make inflation more volatile…If inflation becomes more volatile, we could see nonlinearity on both sides.”
- “The need for monetary policy to take into account risks and uncertainty using a systematic but context specific approach.”
- “A symmetric commitment to respond to inflation dynamics that could de-anchor inflation expectations in either direction.”
We are not sure we can help a whole lot with translating the gobbledygook of much of what Ms. Lagarde read. She was ever so adamant to get her point across about “systematic but context specific approach” that she repeated it twice, slowly. Sorry, still can’t help translate it.
Per the concept of their measures of inflation getting more volatile, we have been showing variations of this picture for three years now. We first referenced it, and the wonderful paper from Riccardo Reis, in our July 2022 Update – “The Pointlessness of Forecasting” Convex Strategies | Risk Update: July 2022 – The Pointlessness of Forecasting.
Figure 3: Stability Begets Instability: Bank of England – 800 years of UK CPI Data
Source: https://personal.lse.ac.uk/reisr/papers/22-whypi.pdf / Millennium dataset of the Bank of England, Convex Strategies
We quoted Riccardo Reis in that note thusly – “If central bankers are risk managers, they should care more about these disasters than about the average outcomes that was so often cited in 2021.”
If anybody wants more details on the ECB’s 2025 monetary policy assessment, you can find it at their website. The link below has links to 1) Monetary policy strategy statement, 2) Overview of the monetary policy strategy, and 3) ECB’s Governing Council press release on the strategy.
Our 2025 monetary policy strategy assessment
The Overview section, if you really want to take the time, lays out quite extensively their carefully constructed assessment. It is a fine example of their own claims as to the importance of communication.
“Monetary policy communication is a monetary policy tool in itself. The better monetary policy is understood, not only by experts but also by the general public, the more effective it will be.” ECB Overview of the monetary policy strategy, 2025.
They are ever so thankful for Rational Accounting Man.
In line with said efforts of using communications as a tool of monetary policy, we had the highly anticipated feature panel at the ECB gathering in Sintra. This year’s panel consisted of repeat offenders from last year’s panel (ECB President Lagarde, Fed Chair Powell, BOE Governor Bailey and BOJ Governor Ueda) along with one new participant, BOK Governor Rhee.
Central Bankers Powell, Lagarde, Ueda, Bailey Speak at Sintra
There isn’t a whole bunch to take away from this panel discussion, mostly just platitudes and cliches. Our reflection is that there is an overall bias towards dovishness, a consensus that the fight against inflation is over and the trend toward yet lower interest rates, while maybe proceeding slower than generally desired, is still well on course.
“Target reached… We faced massive amount of shocks, compounded shocks occasionally, and we are now through that disinflationary process that we have conducted over the last two years.” Christine Lagarde, Sintra 2025.
“Headline inflation has been above 2% for almost 3 years. While, what we call underlying inflation is still somewhat below 2%.” Kazuo Ueda, Sintra 2025.
“Policy remains restrictive, it will continue to be restrictive, but the level of restrictiveness will come down over time.” Andrew Bailey, Sintra 2025.
Figure 4: Core CPI yoy% US (white), Eurozone (blue), UK (papaya), Japan (yellow), Korea (light blue)
Source: Bloomberg, Convex Strategies
One of many bones we might pick, is the extreme lack of balance sheet normalization. It is tough to argue that we have seen all the possible unintended consequences of QE when most of it is still sitting on everybody’s respective balance sheets.
Figure 5: Total Assets Fed (white), ECB (blue), BOJ (yellow). Normalized
Source: Bloomberg, Convex Strategies
Governor Ueda disclosed some of his feelings on the complexity around this particular topic in his response to the final panel question as to what advice he would provide to his eventual successor. He expressed his hope to have returned Japan to price stability (presumably, his official measure, Core CPI, back down to 2% and his unofficial measure, so-called underlying inflation, up to 2%) before handing over to a successor but cautioned about the challenges of the balance sheet.
“I will not have finished reducing our balance sheet to appropriate levels. I would say to my successor take great care in proceeding with further reduction of the size of the balance sheet.” Kazuo Ueda, Sintra 2025.
Good luck with that.
We rarely put much stock into comments from BOE Governor Bailey, but we were pleased to hear that even he has noticed that assumptions around stable correlations are proving to be unreliable. We assume his noting of this has something to do with his regular assertion that their policy rate is still restrictive even as various financial conditions indicators don’t necessarily point towards an equivalent sense of tightness.
“We’ve seen a breakdown in the correlations of the components of a financial conditions index. So, you look at bond yields, you look at exchange rates, you look at equity risk premia, for instance; those correlations are not the ones we’ve tended to see established over time.” Andrew Bailey, Sintra 2025.
Figure 6: Bloomberg UK Financial Conditions Index 25yr history
Source: Bloomberg
We will use one final quote from the Sintra panel to transition to our next topic, let’s call it the “Who’s gonna buy the bonds” section. Fed Chair Powell was asked about the recently proposed changes to the Supplementary Leverage Ratio (SLR) for banks and he gave it solid backing.
“I do fully support what we in effect voted for, what we put out for comment, which is putting the leverage ratio back to where it should be, which is a backstop to risk-based capital.” Jerome Powell, Sintra 2025.
This issue has been an active discussion point ever since the one-year, pandemic induced, temporary exemption expired back in 2021. We highlighted a letter sent from ISDA (International Swaps and Derivatives Association, aka the big banks) to all of the US bank regulators proposing a permanent exclusion of US Treasuries from the SLR in our February 2024 Update – “Where’s the Risk?” Convex Strategies | Risk Update: February 2024 – Where’s the Risk?. We quoted from said letter in that note.
“It is important that banks have capacity to absorb a continued high volume of U.S. Treasury issuance, with the market projected to grow to exceed $35 trillion in the next five years, as well as to facilitate access to cleared U.S. Treasury markets (including cash as well as repurchase and reverse repurchase transactions (together, “repos”) and related derivatives markets.”
The Fed has now come out with a proposal, not quite to the extent of the full exclusion of US Treasuries, to address these desires. Chair Powell provided this press release.
“Because banks play an essential intermediation role in the Treasury market, we want to ensure that the leverage ratio does not become regularly binding and discourage banks from participating in low-risk activities, such as Treasury market intermediation.” Jerome Powell, June 2025.
Tell that to former Silicon Valley Bank shareholders!
Despite much chatter about the conflicts between the current Trump administration and the leadership at the Fed, this is an issue that both are happy to get on board with! Reducing capital in the banking system is seemingly a bipartisan issue. This article gives a fairly simple breakdown of the proposal and notes that it would reduce Tier 1 capital requirements by 27%. The article also reminds us of the killing of the Basel End Game capital increases, regulation changes that they claim would have increased capital requirements by 19%, back in 2023.
Fed proposes 27% cut to tier 1 capital requirements | Banking Dive
There are, however, some dissenting voices. Two Fed Governors voted against the proposal. The article quotes one of them, Michael Barr (the author of the End Game proposal to increase bank capital).
“Significantly lowering the SLR in this manner increases the incentives firms have to game their risk-based requirements by lowering their risk-weighted asset density. This… is precisely what leverage ratios are designed to block.”
As we regularly note, it is difficult to not see regulated financial institutions, and their Rational Accounting Man troops of employees, as tools of financial repression. The efforts to direct savings where desired keep bouncing up with regularity.
This from the ECB.
Crossing two hurdles in one leap: how an EU savings product could boost returns and capital markets
“There is now an urgent need to channel retail savings into European capital markets in order to develop those markets and finance EU priorities. In this edition of the ECB Blog, we show that an EU savings standard could increase retail participation in the capital markets, benefiting savers, boosting investment in EU companies and supporting strategic priorities.”
And this little nugget of evolution coming out of the UK, opening up the window for regulated banks to provide free financial advice to their clients.
Millions to be offered free financial advice under new rules
“Holly Mackay, head of the Boring Money financial data website, said: “This is highly positive, though there is a danger that banks see targeted support as meaning targeted sales.””
What could possibly go wrong?
The problem, of course, is that Sharpe World regulated entities are still choking on all the bonds they bought, at terrible prices (low yields), with tons of leverage, courtesy of the regulatory and accounting incentives to do so. We have previously noted Taiwanese insurance companies as a sort of poster children of the clogged pipes nature of such institutions. Brad Setser over at the Council on Foreign relations has shared this nice bit of work elaborating on some of the aspects of the issues. He makes it pretty clear that, at least under current construction, they are unlikely to be returning as active buyers of bond duration any time soon.
A New Impediment to Balance of Payments Adjustment: Underwater Bonds | Council on Foreign Relations
“A lot of institutional investors around the world (insurers, pension fund, etc.) bought a lot of long-dated U.S. bonds from 2012 onwards… Taiwan’s life insurers bought a ton of bonds as their regulators allowed them to increase their foreign bond holdings as a share of assets… Nearly all of those bonds are all underwater… Most of the losses have not been realized: the bonds can be put in hold to maturity portfolios.”
Figure 7: Estimated Cumulative Bond Losses at Taiwan Insurance Companies
Source: https://www.cfr.org/blog/new-impediment-balance-payments-adjustment-underwater-bonds
It is not hard to imagine a similar picture exists for banks, insurance companies, and pension funds across most of the world. The pipes are clogged!
The good folks over at the Bank for International Settlements (BIS), courtesy of their always worthwhile Annual Report, have also scratched the surface of the supply and demand issue, aka The Hunger Games, around government bonds, amongst many other interesting topics.
BIS Annual Economic Report 2025
Per our current discussion, we would direct folks to page 21 and the subheading of “Fiscal vulnerabilities” within Section I: “Sustaining stability amid uncertainty and fragmentation”. They do a pretty good job, and ever so politely, of laying out the structural challenges of the evolving state of the supply and demand issues in government bond markets. The titling for their Chart 11 has to go down as an all-timer in the realm of tactful understatements.
“Market indicators suggest an abundant supply of government bonds”
Figure 8: BIS Annual Economic Report – Fiscal Vulnerabilities
Source: BIS Annual Economic Report 2025
They do mention a point that we think is at the very heart of the Hunger Games challenge, that being ageing populations.
“Debt levels will also face upward pressure from population ageing, which drives up pension and healthcare costs…”
We give the BIS some credit here because this point is very rarely even touched upon. Take for example, going back to the ECB’s overview of their monetary strategy where, in the final paragraph of their overview, they lay out things that they see as foreseeable challenges going forward.
“While changes are generally difficult to predict, some areas where developments are foreseeable in the coming years that could alter the economic and financial landscape in which monetary policy operates include artificial intelligence; ongoing climate change and nature degradation; improvements in the Economic and Monetary Union architecture, including through progress on the savings and investments union, the completion of banking union and the introduction of a digital euro; the ongoing structural changes in the international financial system, including the increasing role of non-banks; further major economic or financial shocks to the euro area and/or global economies; geopolitical fragmentation; and additional structural changes that affect the inflation process, the equilibrium real interest rate or the growth potential.”
Not even a mention of population demographics.
While we praise the BIS for their small nod, we would suggest that they pursue a little deeper, and not just the added potential costs but also the impact on demand for bond ownership. Retirees don’t need to own 30-year government bonds. As age pyramids invert (i.e. more retired people than working age populations) the dynamics of higher government costs/deficits/debt, pairing off with lesser demand for long term fixed income investments, strikes us as very much an exercise in squaring the circle. Indeed, we would argue it already has lot to do with the situation many countries find themselves in today.
All three sections in the BIS 2025 Annual Report are worth perusing. Section III gets into the suddenly red-hot discussion around stablecoins, and in rather a pessimistic way addressing the premise of ‘what is money’. This conversation has heated up after the passage of the Genius Act by the US Senate (https://www.cnbc.com/2025/06/17/genius-stablecoin-bill-crypto.html) and now moves over to the US House for consideration. This is yet another means by which folks hope to generate some fresh demand for US Treasuries, by legitimizing stablecoins that are explicitly backed with holdings of US Treasuries.
We don’t have much to say on the topic. One can’t help to marvel at the concept of using a tool created to facilitate the escape from the world of fiat to help support the core asset at the heart of the world of fiat. We do, however, have several friends that have opined on the subject. We provide links here to notes from varying perspectives from ‘Friends of Convex’ Pippa Malmgren, Drew Bradford, Marvin Barth and Charlie Calomiris.
(2) Controlled Demolition Warning: Tokenization – by Dr Pippa
Stablecoins show us the future of money — no matter what the BIS says — Capital Brief
(2) Monetary revolution in the making – by Marvin Barth
https://kathleenhays.substack.com/p/calomiris-sees-stablecoins-leading
A space worth keeping an eye on.
We have been talking/writing for years that fiscal dominance and financial repression are the underpinnings of our times. They are to a great extent how we have found our way to our current initial state and will drive how we move along the butterfly wings going forward. If you want to hear it all explained ever so clearly, we would direct you yet again to our friend Bill White and the below interview. Definitely worth the time.
Former Top CENTRAL BANKER Warns: Expect Debt DEFLATION Then HYPERINFLATION | William White
“We will go back to a world in which the threat of fiscal dominance will be met by the reality of financial repression.” William White, June 2025.
It is easy enough to look back over the last 5 years and get a sense as to how the market has treated assets that are considered ‘anti-fiat’ champions. Let’s call our hypothetical example the ‘Anti-Fiat Portfolio’, comprised of gold (GLD US Equity ETF), Bitcoin (XBTUSD Currency), and our Long Volatility proxy (CBOE EurekaHedge Long Volatility Index). We will fiddle with the weightings to get something that has lower risk, defined as Max Drawdown and Downside Volatility, than a traditional S&P/US Treasury 60/40 balanced portfolio. Leaves us with weightings of 35% in Gold, 15% in Bitcoin, and 50% in LongVol. As ever, we assume annual rebalancing.
Figure 9: Hypothetical Anti-Fiat Portfolio vs 60/40 Balanced Portfolio. Scattergram and Return Distribution. 2020 – May2025
Source: Bloomberg, Convex Strategies
Figure 10: Hypothetical Anti-Fiat Portfolio vs 60/40 Balanced Portfolio. Compounding Path. 2020 – May2025
Source: Bloomberg, Convex Strategies
As ever, that just tells us what has happened, not what could have happened, or could happen going forward. Still, you could come to the conclusion that anti-fiat has been an attractive alternative to traditional investment strategies. The hypothetical Anti-Fiat Portfolio, over this relatively short period, has less risk (MaxDD of 13.4% and Downside Vol of 5.9%) than the Balanced 60/40 Portfolio (MaxDD of 19.6% and Downside Vol of 6.4%) and quite significantly better return (CAGR of 21% vs 8.2%).
Per last month’s note, “Just Do It” Convex Strategies | Risk Update: May2025 – “Just Do It”, that’s some pretty good “actual utility”, albeit hypothetical, with a chunky weighting of 50% in a hedging strategy that has negative carry. For those that want a nice follow up to that note, here is a wonderful Medium article from Arne Vanhoyweghen on the topics of Ergodicity and Bounded Rationality.
The Surprising Wisdom of ‘Irrational’ Choices | by Arne Vanhoyweghen | Jun, 2025 | Medium
“Many real-life decisions are non-ergodic, where your outcome over time matters more than the average across a group. Yet traditional economic thinking often treats all situations as if they were ergodic, assuming that maximizing expected value leads to the best outcome for the individual. Instead, Ergodicity economics maximizes your time-average and asks: What if we judged decisions based on how they affect an individual’s wealth, health, or well-being over time, not just on the ensemble average.”
Once you recognize the significance of this difference in perspectives, it is really hard to look upon Sharpe World with much other than dismay.
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