“Is it fate that determines our course, or do we choose our paths afresh with each new decision?” Benoit Mandelbrot, “The (Mis) Behavior of Markets”, 2004.
A great rhetorical question from Mr. Mandelbrot. He floats this out in Chapter IX – “Long Memory, from the Nile to the Marketplace” – of his epic book. This chapter focuses on the efforts of Harold Edwin Hurst to understand the nature of floods and droughts on the Nile. What Mandelbrot is raising, in his moral philosopher-way, is the issue of initial conditions. As he puts it – “how much does the past shape the future?”
The math that Hurst came up with to understand the long memory of the Nile came to be known as the Hurst Exponent and, it turns out, is relevant to all sorts of complex systems, including markets and economies. For an exceptionally good discussion on the use of Hurst Exponents and the role it plays in how financial markets behave, we once again direct you to our friends Niels Kastrup-Larsen and Richard Brennan on the Top Traders Unplugged podcast.
Why Trend Following Works… the Evidence ft. Richard Brennan | Top Traders Unplugged
The guys discuss some of the fantastic work Richard has done, and covers in his recently released book, once again dispelling the premise that markets are independent random walks, hugging tightly around an average with a nice normal bell curve distribution, and with steady predictable volatility. Using the Hurst Exponent, amongst other tools, and looking across 40 years of data on 68 different futures markets (equities, bonds, currencies, energies, metals and agriculturals), he shows that the opposite is indeed true.
History and initial conditions matter. Market returns are far from normally distributed. Volatility clusters. Same things Mandelbrot explained.
“So, if your risk model assumes bell curve returns, you’re not slightly underestimating the probability of large losses. You are underestimating it by orders of magnitude.” Richard Brennan, March 2026.
It really is an interesting conversation and lines up precisely with the discussions we have been having throughout the noise over the last month. As Niels and Richard mention, we frequently use the forest fire analogy as an example of the self-organizing criticality nature of markets. As that might relate to circumstances over the past month, one might say that the war/fire doesn’t cause the fragilities but, rather, exposes where the fragilities already existed.
We cannot help but go back to this great quote from our January 2026 Update – “Simon’s Scissors” Convex Strategies | Risk Update: January 2026 – “Simon’s Scissors”
“History is the study of decisions, not of events, and many decisions are best understood as the outcomes of larger systems rather than individual acts of will.” Dan Davies, August 2025.
We discussed in that note Herbert Simon’s analogy of the two blades of scissors as his framing for his theory of Bounded Rationality. We all function under the necessity of operating in the interaction of the two blades: one that represents the environment and circumstances that we find ourselves in (initial conditions) and the other being our own capacity to respond to said circumstances. This is exactly what Mandelbrot is pointing to in his rhetorical question. It is both. History matters to the circumstances we find ourselves in and our own decisions will impact our own future that has yet to be written.
The conflict in Iran is not a random event; it is its own result of a long series of decisions and the memory that has been carried through time. Likewise, how the shock from the conflict reverberates across markets and economies will depend upon the memory and, in particular, the fragilities that have developed within them. Again, the war doesn’t cause the fragilities; it merely exposes where they already existed.
We have long discussed our analogy of the Hunger Games to explain the growing competition amongst issuers of government debt. Readers can go back and review some of our past work around the Hunger Games in our October 2023 and June 2024 Updates Convex Strategies | Risk Update: October 2023 – “The Hunger Games” Convex Strategies | Risk Update: June 2024 – “Hunger Games II”. The gist of the analogy is that, after building up unprecedented levels of Debt/GDP, facilitated by central bank gratuitous policy (ZIRP, NIRP, QE, YCC, FAIT, etc) and explicit financial repressing regulatory policy (BIS Regulatory Guidelines for banks, Solvency Rules for insurers, IAS19 Accounting Rules for pensions), we are now in a world that debt issuers need to compete for an ever-dwindling pool of willing buyers. The Rational Accounting Man buyers that were the tools of financial repressing policies are buried under mountains of terrible bond holdings, the false Sharpe World claims of bond benefits to investors have been stripped bare, and the inexorable demographic circumstance of ever fewer taxpayers/savers has hit pivot points in most major economies. This is the fragility that the current conflict is exposing.
Figure 1: Brent Crude 1st Future (blue) and Urea Mid-East 1st Future (white). 2021 – March 2026. Normalized
Source: Bloomberg, Convex Strategies
That analogy has now evolved into an expanded version, call it the Hunger Games and Resource Wars. The Iran conflict has brought that to even greater light. Note above the impact on two critical base resources – oil and urea (fertilizer). This has obvious implications for existing Hunger Games and Resource Wars competitors, everywhere, but particularly on those that are dependent on imports of these items (and all sorts of related items) and, even more so, those with a concentration of that dependence on said items that move through the bottleneck of the Straits of Hormuz.
Europe stands out as a group of Hunger Games and Resource Wars competitors that very likely find themselves with a relatively challenged set of initial conditions. History gives us some hints as to how they might respond.
Figure 2: Brent Crude Oil 1st Future (blue), Euro 2yr Govt Bond (white), ECB Deposit Rate (orange). Oct 2000 (white-vertical), July 2008 (red-vertical), July 2011 (green-vertical), Sept 2023 (purple-vertical). 1999 – March 2026
Source: Bloomberg, Convex Strategies
Quite clearly, we can see that over its quarter century history the EUR interest rates (using 2yr bond yields as our proxy) have followed oil prices and, with some lag, ECB policy rates have followed 2yr bond yields. The Iran related spike in oil prices (amongst other resources) has had an immediate and direct effect on EUR interest rates: where the fragility already existed.
We just discussed, back in the January 2026 “Simons Scissors” Update linked above, the challenges for many of the central banks who, after getting policy rates above their 30yr bond yields in their 2022-2023 tightening efforts, have seen long duration yields persistently rise as they proceeded to reduce short term policy rates. It could be that the long memory of markets is cognizant that the lurking implications of recent inflation, and poor policy response, are still percolating under the surface of the system.
Figure 3: Euro 30yr Govt Bond (purple), Euro 2yr Govt Bond (white), ECB Deposit Rate (orange). March 2022 (red). 2021 – March 2026
Source: Bloomberg, Convex Strategies
We wrote about the similar circumstances in great depth back in our March 2022 Update – “The Most Dangerous Peg in the World” Convex Strategies | Risk Update: March 2022 – The most dangerous peg in the world.. It is definitely worth going back and skimming through this note as a reminder of what things looked like at the tail-end of the “this is transitory” misdirect-era. In the ECB’s March 2022 policy meeting, they maintained their Deposit Rate at -0.50% and continued on with peak QE bond purchases, with no signalling of future reduction of extreme accommodative policy. This with their price stability measure at 7.4% and market rates rapidly pulling away from their policy rate. We quoted ECB President Lagarde with this all-time classic from late in 2021.
“We really looked and very deeply tested our analysis of the drivers of inflation, and we are confident that our anticipation and our analysis is actually correct.” Christine Lagarde, October 2021.
Ms. Lagarde, at least publicly, is not a believer in the science of chaos and complexity. We would be surprised if she is aware of the Hurst Exponent. She regularly portrays history as very explicitly a series of unforeseeable events. The spike in prices from 2021 onwards was a result of supply shocks, in her telling, and had nothing to do with the historical extreme efforts by her and the ECB to actually generate the very inflation that then eventually arrived. That wasn’t the kind of inflation they were trying to create, apparently.
We, however, would argue that their efforts at manipulating price stability is in fact a near perfect parallel to Hurst’s work on the rightsizing of a dam on the Nile.
Figure 4: Eurozone HICP YoY%. 1997 – March 2026 (white). Symmetric Target July 2021 (purple). 1997 – July 2021 Average (red). July 2021 – March 2026 (green). 1997 – March 2026
Source: Bloomberg, Convex Strategies
In July 2021 the ECB announced that it would transition from their previous practice of targeting 2% annual rate of change with an objective of “close to but below 2%” to a renewed objective of “an inflation rate of 2% over the medium term, with a symmetric commitment”. In Hurst terms, they went from wanting to protect against too little water in the reservoir during droughts but not risking too much during floods (keep it close to but below 2%), to redefining it to a symmetric willingness to take flood risk. This, no doubt, as a result of the clustering drought years post-GFC.
Figure 5: Eurozone HICP Index. 1997 – March 2026 (white). Historical Trend 1.8% (red). Symmetrical Target July 2021 (purple). 1997 – March 2026
Source: Bloomberg, Convex Strategies
Once they removed the flood-prevention bias, they started to let the reservoir fill up during heavy wet years, and it just kept on filling. Now you are at a point where the reservoir is at a near critical state, and it looks like we are about to get another heavy bout of rainfall in the form of a very explicit supply shock. The volatility clustering is on the other side now and the dam is far more fragile as the long memory of the reservoir applies its pressure. We can make the same point about the US and their removal of flood-prevention prioritization with the ill-fated implementation of Flexible Average Inflation Targeting (FAIT) in August 2020.
Figure 6: US CPI YoY% (white). FAIT Framework Aug 2020 (purple). 1997-Aug 2020 Average (green). Aug 2020 – March 2026 Average (red). 1997 – March 2026
Source: Bloomberg, Convex Strategies
While the US has obvious advantages when it comes to the Resource Wars, as in they actually have some of their own, the Fed has nevertheless allowed the reservoir to get very full.
Figure 7: US CPI Index (white). FAIT Framework Aug 2020 (purple). Historical 2% Trendline (red). 1997 – March 2020
Source: Bloomberg, Convex Strategies
We have been talking about this point for quite some time, first highlighting the below chart in our July 2022 Update – “The Pointlessness of Forecasting” Convex Strategies | Risk Update: July 2022 – The Pointlessness of Forecasting.
Figure 8: “Stability Begets Instability” 800 Years of CPI in the United Kingdom. 20yr CPI Blocks Average vs Volatility
Source: The Burst of High Inflation in 2021–22, Bank of England Millennium Dataset, Convex Strategies
If we simply stick to the 20yr date segments as chosen by the author (Ricardo Reis), we can see the implications on dam building strategies from the Bank of England.
Figure 9: UK CPI YoY% (white). Dec 2016 (purple). 1997 -2016 Average (green). 2017 – Feb 2026 Average (red). 1997 – Feb 2026
Source: Bloomberg, Convex Strategies
It is the same basic story. If these folks are building dams and managing flows based upon a simplistic view of recent historical clustering of droughts, we have a very high likelihood that flood risks have fatter tails than normal distributions would estimate. Indeed, even the recent period’s volatility is significantly on the low side of the full history of past outcomes.
Figure 10: UK CPI Index (white). Historical Trend 2% (red). Dec 2016 (purple). 1997 – Feb 2026
Source: Bloomberg, Convex Strategies
For an extremely in-depth insight into obfuscating the challenges and implications of the current set of initial conditions in the UK, you can take a look at this lengthy piece of work from the UK government’s Office for Budget Responsibility (OBR), in their March 2026 Economic and Fiscal Outlook.
Economic and fiscal outlook March 2026
This entire note takes our premise of “the pointlessness of forecasting” to new levels of ridiculousness. A quick scan through will find a vast number of charts that are 1) first chart below: explicit red flags that get brushed aside, or 2) second chart below: utter nonsense in terms of forecasts of potential sensitivities.
Figure 11: UK National Accounts taxes as share of GDP
Source: Economic and fiscal outlook March 2026
As relates to this chart, they cautiously note:
“There is significant uncertainty around the forecast increase in the tax take over the next five years… a higher level of the tax take increases the risk that incentives within the tax system distort or constrain economic activity by more than expected.” UK OBR, March 2026.
No mention of the impact of declining working age population. Despite fewer taxpayers, tax take as a share of GDP rises forever into the future, according to the OBR.
Their CPI forecasts are for forever sustained at-target normalcy with narrow symmetrical probability bands representing possible divergences.
Figure 12: UK CPI inflation and forecasts
Source: Economic and fiscal outlook March 2026
“There are upside and downside risks around our central forecast for inflation. Purely based on past forecast errors, there is a one-in-five chance that CPI inflation in 2026 will be above 2.8 per cent and a similar chance that it will be below 1.9 per cent. Upside risks to our central forecast include more persistently elevated inflation expectations from households and businesses feeding into wage and price-setting behaviour. Downside risks include the possibility that tighter monetary policy (relative to recent history), both in the UK and internationally, could have a stronger effect on demand than currently anticipated.” UK OBR, March 2026.
Pointless. We look forward to seeing updated reality when the March 2026 CPI releases appear in April.
Connected to that we will zoom in briefly on some of the fragility shown in various 2yr bond yields.
Figure 13: 2yr Yields on US Treasury (blue), Euro Govt Bonds (white), UK Gilts (green). 2024 – March 2026
Source: Bloomberg, Convex Strategies
Using recent history as a guide to their behaviour, we can guess at what sort of response vulnerable economies like the Eurozone are likely to pursue – subsidise the cost increases! Europe was prolific in their fiscal subsidies back in the 2021-2022 pricing episode. Right across Europe, at both the individual country level and the EU level, various forms of cost relief (subsidies, tax-relief, allowances, price caps, etc.) were applied. Almost all of these at the cost of widening fiscal deficits and more bond issuance into the arena. The same strategy has, once again, immediately arisen in the face of the Iran related supply shocks and price jumps.
A simple little note from economist John Cochrane, famed for his work on the The Fiscal Theory of Prices, on just this issue.
How to turn a price shock into inflation
” How does a relative price shock — energy costs more than other goods—turn in to overall inflation? Largely by policy responses to the energy shock. Europe invented a doozy in the last price rise and looks set to do it all over again.” John Cochrane, March 2026.
John links to, and quotes from, this article from a Greek news site.
Energy relief measures may be on the way for Greece | eKathimerini.com
“The proposed tools – including price caps on gas, expanded long-term energy contracts and relaxed state aid rules – could help shield vulnerable households and stabilize electricity costs. Jorgensen also pointed to the need to ease the link between gas and retail power prices.”
John’s note talks about the downstream, second order, effects of these types of subsidy policies in the face of an actual reduction of supply. The pain gets pushed to the marginal buyer somewhere. In a global perspective, that marginal buyer is, inevitably, the countries that are too poor to provide their own subsidy. It is very much a beggar-they-neighbour practice and directly relevant to the Hunger Games and Resource Wars competition.
We wouldn’t suggest holding out much hope that Europe has learned from their own recent history. Without accountability there can be no learning. A quick perusing of this, unbelievably ironic, speech from Christin Lagarde, on the occasion of her receiving the 2026 Paul A. Volcker Lifetime Achievement Award, should douse any hopes of improving risk management inside the ECB.
Turning size into scale: Europe’s new growth model
Somehow, Ms. Lagarde manages to give an entire speech on Europe’s new growth model, without even once touching on the vulnerability to key energy resources. Literally, just days before the implications of their concentrated dependence was laid bare. She did, however, hint at a couple of relevant Hunger Games related issues.
“…this model has meant exporting our savings at a time when we face substantial investment needs at home.” Christine Lagarde, February 2026.
“Government spending on defence and infrastructure is rising markedly…” Christine Lagarde, February 2026.
“The current account surplus fell to 1.6% of GDP in 2025, down from 2.7% in 2024, and our projections indicate that it should remain around that level. A significant share of what remains reflects the savings behaviour of an ageing population.” Christine Lagarde, February 2026.
Hmmm…
Likewise, Ms. Lagarde gave a speech titled “Preparing for geoeconomic fragmentation” at the prestigious Munich Security Conference. Sounds almost foresightful! Sadly, not. Once again, she misses the implications of their dependence on and fragility around energy resources.
Preparing for geoeconomic fragmentation
“The ECB needs to be prepared for a more volatile environment. As industrial policy becomes more assertive, geopolitical tensions rise and supply chains are disrupted, financial market stress is likely to become more frequent… That is why, last week, the Governing Council decided to expand our EUREP facility – our standing facility that offers euro liquidity against high-quality collateral.” Christine Lagarde, February 2026.
We also got the results of the ECB’s March 19th policy meeting, as well as revised economic projections. Despite moderate increases, due to the shock of the war, to their projections on prices, they chose to maintain policy rates where they are. The link below of the post-meeting press conference is an absolute must read.
As a general overview of Ms. Lagarde’s representation of the Governing Council’s perspective, we give you this tidbit.
“So I think my goal and the goal of the Executive Board was to make sure that governors were starting from the best-informed basis to hold their in-depth discussion. And I would characterise the overall mood of the group as being calm, being determined and being laser-focused on the information that we have, the projections that we received and all data that can be analysed and factored into our decision-making process. Our decision was unanimous. You asked me about a range of views. There was no range of views. It was a unanimous decision that was taken not to move rates at all. We are going to continue doing what we have been doing, and that’s addressing the second part of your question. We are starting from a good base. I’m not saying that we are in a good place. We are well positioned, and actually you find that in the monetary policy statement. I think we are both well positioned and well equipped to deal with the development of a major shock that is unfolding, and we will continue doing that.” Christine Lagarde, March 2026.
Unanimous. No range of views. Talk about fat tails!
For something sensible inside the ECB, we tend to lean towards Isabel Schnabel. Below is a link to slides from a presentation she gave on March 27th, 2026.
Monetary policy in times of geopolitical fragmentation
Inside she shares the latest ECB staff projections.
Figure 14: ECB Staff Projections on Real GDP (left) and HICP Inflation (right)
Souce: Monetary policy in times of geopolitical fragmentation
As usual, everything is projected to return to target. Even the “severe scenarios” quickly return to normal. No memory. No fat tails. No volatility clusters.
Ms. Lagarde, kicking off a trend of “Navigating” speeches, gave this March 25th, 2026, speech, “Navigating energy shocks: risks and policy responses”.
Navigating energy shocks: risks and policy responses
She notes the risk of a fiscal response, as we discussed above, strengthening the pass-through of the shock.
“The fiscal response will matter. Targeted government policies can help smooth the shock by reducing energy demand and compensating lower-income households. But broad-based and open-ended measures may add excessively to demand and strengthen the pass-through.” Christine Lagarde, March 2026.
ECB Vice-President, Luis de Guindos, gave his below “Navigating” speech on March 26th, 2026, “Navigating turbulence: challenges for Europe and the path ahead.”
Navigating turbulence: challenges for Europe and the path ahead
He knows the solution to the challenges – more Europe.
“The current geopolitical turmoil adds to a series of overlapping crises that require a unified European response. It is a call for the EU to focus on its circle of influence by reducing internal fragmentation, standing up for its values, addressing its external vulnerabilities and building strengths to face emerging challenges.” Luis de Guindos, March 2026.
Platitudes might be the ECB’s number one policy tool of choice.
Europe and the UK, obviously, are not the only ones with fragilities in the current world. Any number of Asian economies have similarly managed themselves into very high levels of dependence on goods that need to move through the Straits of Hormuz. Our friends at Wigram Capital Advisors https://wigramcap.com/ have kindly allowed us to share some of their recent visuals that make it all very clear. They have been doing great work on these dependencies; we strongly advise people to get in touch with them.
Figure 15: Asia Effective Gulf Oil Dependence and Days of Oil Reserves
Source: https://wigramcap.com/
Pretty self-explanatory. 1) Much of Asia is very dependent for their oil (and gas, and jet fuel, and fertilizer) on Gulf providers. 2) Some folks carry shockingly low reserves. The likely longer term implications, even once we get beyond the initial crisis, will be the necessity to diversify suppliers, for the likes of Japan and Korea, and the extreme necessity to build and maintain higher levels of reserves, for the likes of Australia and Vietnam (both already having been in the press for taking critical measures to deal with extreme jet fuel shortages).
Another issue out here in Asia is the role that China plays as one of the key providers of refining services for the region, with places like Australia and New Zealand nearly fully dependent on China for their refined products.
Figure 16: Annual China Exports of Refined Products. YTD 2026 in red
Source: https://wigramcap.com/
The problem being that China could decide not to carry on with the contracted obligations to provide refined products. Mostly anecdotal but whispers abound that refined products are not leaving China. Wigram’s tracking of official numbers would seem to reflect as much, even before the official kicking-off of hostilities in Iran.
Just like with EUR interest rates, it is easy enough to find the Asia markets that have fragile exposures to goods moving through the Straits of Hormuz.
Take implied offshore forward points for Indian FX markets.
Figure 17: Brent Crude 1st Future (blue) and INR NDF 12mth Fwd Points (orange). 2024 – March 2026
Source: Bloomberg, Convex Strategies
India is one of the world’s largest importers of oil and gas, as well as direct and indirect dependence on fertilizer related products. The RBI has already been very active in battling to defend the Rupee, both through intervention as well as a series of reactive regulatory changes.
Another country that is clearly vulnerable is Korea. Below we have shown oil prices alongside USD/KRW FX 10delta Call Implied volatility and it is remarkable how precisely these two markets have traded step for step with each other.
Figure 18: Brent Crude 1st Future (blue) and USD/KRW 10d Call Implied Volatility (yellow). 2025 – March 2026
Source: Bloomberg, Convex Strategies
The wealthy Asian countries, just like their European friends, have all likewise been very quick to jump on the government subsidy bandwagon. Japan, Korea, and Singapore were all quick to announce government means to mitigate the price impact on consumers. All efforts that should maintain demand and economic activity at pre-crisis levels and force the burdens of dwindled supply elsewhere.
Japan stands out for the sheer scale of their dependence on energy resource imports. On the bright side, they are wise, or experienced, enough to carry significant reserves. An example that you must think others will consider replicating going forward. Still, the implications of the current supply shock are hard to ignore. Those implications maybe fall most directly on the one major central bank, the Bank of Japan (BOJ), who is still running self-proclaimed “highly accommodative” monetary policy.
Figure 19: JGB 30yr Yield (purple), JGB 2yr Yield (white), BOJ Policy Rate (orange). 2021 – March 2026
Source: Bloomberg, Convex Strategies
The BOJ has a long way to go if they ever felt the need to invert their curve.
It is easy enough to see the implications of Japan’s already existing fuel subsidies by comparing their Headline CPI number with what is commonly known as Core-Core CPI, i.e. CPI excluding Fresh Food and Energy. We have also included in figure 20 the USD/JPY FX rate which, not surprisingly for a major energy importing country, has a close relationship with their measures of inflation.
Figure 20: Japan CPI YoY% (white), Japan CPI ex Fresh Food and Energy YoY% (orange), USD/JPY FX Rate (purple). 2011 – February 2026
Source: Bloomberg, Convex Strategies
The current divergence between Headline CPI (white line) and CPI ex Fresh Food and Energy (orange line) is the result of already implemented fuel cost subsidies from late last year. The newly implemented subsidies, related to the Iran conflict, went into effect on 19 March 2026, and will add even more to that divergence in the immediate term.
Despite what should be obvious concerns about the downstream impacts of skyrocketing resource import costs, and the related weakening of their currency, the BOJ remained steady at their March policy meeting. They are, however, assumed to be laying the groundwork for an upcoming hike, presumably from 0.75% to 1.00%, at their upcoming April meeting.
We say this as the BOJ themselves have come out with a recent slate of research papers addressing many of the issues we have been highlighting for some time.
For example, this paper, titled “Supply Constraints and Inflation Dynamics”, basically digs into the implications of volatility clustering in terms of their growing sensitivities to various accumulating supply constraints. The conclusion sums it up very clearly.
Supply Constraints and Inflation Dynamics
“The results of the analysis suggest that the intensification of supply constraints has impacted Japan’s inflation dynamics through the following channels. First, intensifying supply constraints on labor and materials had a persistent impact on the inflation rates. Second, intensification of labor supply constraints contributed to recent inflation increases by heightening the sensitivity of inflation rates to demand fluctuations (i.e., nonlinearity). The results suggest that persistent supply constraints, under accommodative financial conditions, also led to a recent rise in inflation expectations… Furthermore, the analysis implies that inflationary pressures arising from intensifying supply constraints have become more frequent and significant in recent years. Looking ahead, the further intensification of labor supply constraints could strengthen inflationary pressures in a nonlinear manner.” Bank of Japan, February 2026.
They include this wonderful chart showing the persistence of various supply shocks. And, again, this is before the Iran related shocks have shown themselves. You don’t have to look at this chart for very long to wonder if “highly accommodative” is the appropriate policy setting. It is always nice to see Sharpe World practitioners, gingerly, stretch their methodology to incorporate such concepts as to something behaving in a “nonlinear manner”. This paper is very worth the time to dig through. If nothing else, it will give you some idea of the gap between “what is known” internally at the BOJ and “what is said publicly” by the BOJ.
Figure 21: Japan Historical Decomposition of CPI Inflation Rate (excluding fresh food and energy)
Source: Bank of Japan
Along a similar theme, BOJ staffers released this paper in March – “Developments in the Natural Rate of Interest and the Assessment of the Degree of Monetary Accommodation”. This note updates some of their methodology and poses the possibility that they have been underestimating both the mythical “natural rate of interest” as well as the “potential growth rate” for Japan. This leads to the enlightened (in our opinion) conclusion that maybe some trial and error might be a worthy strategy.
“As highlighted in this paper, although the natural rate of interest is an important concept for the conduct of monetary policy, it is difficult to pin down the level of this rate in advance, and estimates of the rate therefore need to be viewed with considerable latitude… Based on this premise, the Bank considers it appropriate to continue to adjust the degree of monetary accommodation while examining how economic activity and prices respond to changes in short-term interest rates. In particular, as the policy interest rate gradually approaches the neutral range, to smoothly achieve the 2 percent price stability target, it will become more important than ever to correctly gauge how the degree of monetary accommodation is changing. Ultimately, the Bank will make a comprehensive judgment on developments in economic activity, prices, and financial conditions.” Bank of Japan, March 2026.
Dare we say, a little glimmer of modesty and common sense? Admitting they don’t know what the mythical numbers are, therefore, it is possible that a high degree of monetary accommodation isn’t necessarily appropriate. So, get on with removing the accommodation and see how things go. Seems rational to us!
Figure 22: Japan Real Interest Rates by Maturity
The BOJ should hike in April. They have laid the groundwork with these research pieces and with public comments from both BOJ officials as well as government officials. The market has more or less priced in the hike. Not hiking would surprise the market and likely put yet more pressure on the topside of the USD/JPY FX rate. It still isn’t totally clear to what extent moving from -1.75% real policy rate to -1.50% real policy rate will result in removing the sustained upside pressure on USD/JPY, particularly as the fiscal side continues to subsidise the cost of the key imported resource.
One last topic, which we won’t go into in this note, but just wanted readers to keep an eye on it. Something we would put in the Ben Hunt category of “why am I reading so much of this now?”. There has been a proliferation of work from officialdom sources on the matter of central bank balance sheets versus bank reserves. Here are links to just a few of the notes.
The banking system and the demand for reserves – Dallasfed.org
A User’s Guide to Reducing the Federal Reserve’s Balance Sheet
It could be broad Hunger Games implications, just prepping all of us for the banks to notch up their role in the financial repression and ever more government bond holdings. This of course lines up with the reduced capital requirements, walking away from Basel End Game, and permanent softening of the SLR. Maybe it has to do with the nomination process for Kevin Warsh and his open advocacy for shrinking the Fed’s balance sheet. Maybe it is just more distraction to separate the massive balance sheets of central banks from their ongoing failure to sustainably achieve their price stability targets. We think it is something worth keeping an eye on.
Finally one last chart, harkening back to previous points that we had made (https://convex-strategies.com/2026/01/14/risk-update-december-2025-a-matter-of-time/) regarding debasement and that, looked at in gold terms, maybe all-time highs in equity indices didn’t imply egregious expensiveness. We could make the same point about oil.
Figure 23: Brent Crude Oil 1st Future to Gold Ratio. 1989 – March 2026
Source: Bloomberg, Convex Strategies
The debasement of fiat will have a very long memory. The ability to continue to do so has very direct implications on the ongoing competition we have dubbed the Hunger Games and Resource Wars. The fragility that drives the Hunger Games is increasingly ubiquitous. Current circumstances seem destined to lead to ever more government spending around solidifying positions within individual resourcing dependencies. Military spending will continue to rise. Support for aging populations continues to accumulate. Taxpaying and saving populations, aka working-age populations, will inevitably decline. The competition to issue bonds and secure critical resources isn’t going to simply fade away. Convexity and preparedness seems a much better solution than pointless forecasting.
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