Issues 2021 

Doug Nolan



Fragility. Last year exposed myriad fragilities. 

The U.S. stock market went from all-time highs to an emergency FOMC meeting in ten sessions. The S&P500 lost more than a third of its value in just 21 trading days. 

Q2 GDP collapsed at a 31% annualized rate. Financial conditions tightened dramatically, with illiquidity and dislocation erupting throughout the markets – equities and fixed income. 

The year demonstrated the fragility of social stability. Frail confidence in our institutions was similarly revealed. 

A historic rally saw stock prices end 2020 at record highs. Financial conditions loosened spectacularly, with the year seeing record investment-grade and high-yield bond issuance. 

Record IPOs and SPACs. It was a year of surging trading volumes for both equities and options. The Fed’s balance sheet expanded almost $3.2 TN in 43 weeks.

Financial fragilities were exposed – and then seemingly resolved at the generous hands of the Federal Reserve (and the global central bank community). 

For years now, my beginning of the year “Issues” pieces have featured a key Credit Bubble maxim: “The Bubble either further inflates or bursts.” 

While easier to dismiss than ever, this dynamic has never been as germane. The Fed-induced Bubble is raging out of control. Monetary Disorder is acute and highly destabilizing. Sustainability must be questioned. 

The system to begin 2021 in the throes of historic late-cycle “Terminal Phase Excess.” 

One cannot overstate the potential damage this ongoing epic Monetary Disorder can inflict upon financial, economic, social and political stability. 

The brazen assault on our U.S. Capitol this week was both terribly distressing and ominous. Covid infections continue to run out of control, with single-day deaths this week surpassing 4,000 for the first time. 

Meanwhile, Tesla surged 25% this week (794% y-o-y) - increasing market capitalization to $834 billion. Bitcoin surpassed $40,000 this week, with one-week and one-month gains of 38% and 100%. 

The small cap Russell 2000 jumped 5.9% this week, with the S&P400 Midcaps up 4.8%. The “average stock” Value Line Arithmetic Index rose 4.6%. 

The KWB Bank Index surged 8.5% during the first five trading sessions of the year. 

The Philadelphia Oil Services Index jumped 13.6%. 

Beginning where it left off in 2020, the Goldman Sachs Most Short Index surged 10.1% in a week.

There is at least some discussion of “Bubbles,” a sign of how flagrant excess has become. 

To be sure, years of Bubble excess have inflated into a full-fledged stock market and financial mania. This is an extremely dangerous situation: speculative blow-off dynamics with acute latent fragilities. 

Nonetheless, confidence in the Federal Reserve’s capacity to sustain the boom is more deeply ingrained than ever. Last year’s unprecedented crisis measures emboldened financial speculation. Underlying fragilities are disregarded. 

The general view is that risk can be readily ignored – it must be to capture easy trading profits. The Fed has everything in better control than ever. Our central bank will ensure that financial conditions remain exceptionally loose.

Key Issue 2021: Can the Fed sustain ultra-loose financial conditions?

There’s a fallacy that became only more toxic during 2020: That the Fed readily manages and controls financial conditions. Markets, financial systems and finance, more generally, evolve over time, with this evolution significantly influenced by policy measures. The appearance of Fed control persists only so long as the Bubble inflates. 

For about three decades, the Fed has accommodated, nurtured and backstopped leveraged speculation – arguably to the point where speculative leveraging is the prevailing force dictating underlying financial conditions. In a “risk on” backdrop, expanding speculative Credit (leverage), loose financial conditions, and speculation all feed a self-reinforcing Bubble Dynamic. But the wildness awaits… 

We witnessed this past March how quickly de-risking and deleveraging can erupt into illiquidity, dislocation and panic. Unprecedented speculative leverage had accumulated across global markets. Associated latent fragilities were exposed – and unprecedented policy measures were required to hold collapse at bay. In the end, in excess of $3 TN of Fed liquidity ($8.5TN from “G4” central banks) reversed the powerful forces of de-risking/deleveraging. A potent new speculative cycle was unleashed.

Key Issue 2021: Will the latest speculative cycle, arguably the most egregious and destabilizing yet, be sustained through the year? 

Ebullient markets celebrate the Fed’s unprecedented 2020 measures, with more faith in “whatever it takes” than ever. More sober analysis would recognize the relationship between systemic speculative leverage, underlying fragility, and the scope of the Fed’s response necessary to thwart Bubble collapse. 

Importantly, the need for such monumental Fed measures confirmed the unprecedented scope of leveraged speculation and speculative excess more generally. 

The Fed and global central bank 2020 crisis response pushed unparalleled leveraged speculation and financial excess to even more precarious extremes. While presumed otherwise in the markets, last year’s market bailout and resulting mania have significantly exacerbated what was already acute Bubble fragility. 

Typically, a speculative cycle’s manic phase has a limited duration. As in life, it becomes difficult to sustain the intensity of extreme euphoria. But this is the most extraordinary of cycles. 

Myriad signs of rank excess that in the past would have aroused concerns from the more sophisticated market operators are today paid no heed at all. Not with markets over-liquefied and the Fed determined to inject $120 billion monthly for the foreseeable future. 

This promotes an extended cycle – an elongated “Terminal Phase” – with only more egregious speculation and speculative leverage.

The 2008 crisis was labeled “a hundred-year flood.” Crises inflict enormous pain. 

Normally, lessons are learned, and behaviors are altered. Speculators are chastened, while policymakers assume a more assertive role in safeguarding against lending, debt accumulation and speculative excesses. 

But contemporary central bank doctrine has transformed age-old dynamics. QE, zero rates and using asset inflation as the key mechanism for system reflation ensure anomalous dynamics. 

The Bubble was reflated and then some, ensuring only greater future Bubble collapses. 

The global Bubble was again at the precipice in 2020, with reflationary policy measures employed more quickly and in incredible dimensions. Bubbles were rapidly resuscitated. Pain was ameliorated before it altered risk tolerance or speculative impulses. 

It would be highly unusual to have back-to-back years of financial crisis. But the speed by which intense speculative excess reemerged post-crisis has been extraordinary. 

There are some similarities to the post-LTCM rally that briskly ripened into the 1999 technology stock mania – with less than 18-months from bailout to a major market top in March 2000. 

Yet the scope of the current global Bubble across asset classes so dwarfs 1999. Between September 1998 and the end of March 1999, Federal Reserve Assets expanded $55 billion to $580 billion. For this cycle, the expansion of Fed Credit is now up to $3.580 TN in 69 weeks. 

Central bank largess spurred history’s greatest Credit expansion – in the U.S., China and globally. Many governments over the past year ran deficits surpassing 10% of GDP. 

The U.S. fiscal deficit exceeded $3.0 TN, or approaching 15% of GDP. 

In the face of an unprecedented supply of new bonds and debt, market yields nonetheless collapsed. Central bankers completely disabled the market pricing mechanism. 

January 8 – Bloomberg (Jordan Fabian): 

“President-elect Joe Biden on Friday called for trillions of dollars in immediate further fiscal support, including increased direct payments, after a surge in coronavirus cases caused U.S. payrolls to drop for the first time since April. 

‘The price tag will be high,’ Biden said of his planned package… He promised to lay out his proposals next Thursday… ‘It will be in the trillions of dollars.’ Biden invoked images of the unemployed waiting in long food lines and added a dire warning: ‘If we don’t act now, things are going to get much worse and harder to get out of a hole later.’ 

Biden made the call for new assistance – including boosting stimulus checks to $2,000 -- after an unexpectedly poor December jobs report…” 


Ten-year Treasury yields surged 20 bps to start the new year to 1.12% - the high since March 19th. Long-bond yields jumped 23 bps to 1.88%. 

After winning both Georgia Senate runoff elections, at 50 seats the Democrats have effectively accomplished “clean sweep” control of Washington. 

Presumably, next week we’ll have a better idea of the size of the new administration’s stimulus plan. 

For sure, the Treasury market now faces massive supply – with a fiscal deficit likely to rival last year’s $3.1 TN. After buying the majority of 2020’s net Treasury issuance, the Fed is poised to purchase a Trillion or so in 2021. 

That leaves a significant hole. In addition, inflationary pressures are germinating. 

The 10-year Treasury inflation “breakeven” rate jumped nine bps this week to 2.07%, the high since October 2018. 

Crude (WTI) prices surged $3.72 this week, with gasoline up 9.4% and natural gas gaining 6.3%. 

Copper rose 4.4%. Corn jumped 2.5% this week, with soybeans up 4.6%. Strong price gains were posted by cotton, palm oil, rubber and live cattle. 

Fed vice chair Richard Clarida spoke Friday afternoon before the Council on Foreign Relations. Bloomberg headlines captured the gist of his message: “Time to slow pace of bond buying ‘Well down the road.’” 

“Can be quite some time before we think about tapering.” Chicago Fed president Charles Evans this week commented, “Frankly, if we got 3% inflation that would not be so bad.”

Issue 2021: The Fed is Playing with Fire.

I understand the deep complacency. The Fed has not felt pressured by the markets to raise rates since 1994. In a more normal environment, the bond market would look at the confluence of mounting inflationary pressures and Fed indifference with trepidation. 

Throw in unprecedented supply and booming risk markets and you’ve got all necessary ingredients for a brutal Treasury bear market. Yet fear remains difficult to come by. There is already talk of how much higher market yields would need to move before the Fed steps in with larger purchases of long-dated Treasuries. 

“Whatever it takes.”

I see these breakdowns in monetary management, market function and fiscal discipline likely coming to a head in 2021. Would the Fed significantly boost QE in the face of manic risk markets and a recovering economy? 

I see the Republican party emerging from disarray to return to its fiscal conservative roots. The Federal Reserve faces major political risk when it is viewed as financing the Democrats liberal agenda. Issue 2021: Fed credibility.

Another massive stimulus program risks turning both Republicans and an increasingly inflation-focused bond market against massive Fed monetization. There is, as well, the not inconsequential risk of a disorderly decline in the dollar. 

The confluence of huge trade deficits, previously unimaginable fiscal deficits, massive Fed monetization, over-indebtedness, and a vulnerable financial Bubble places dollar stability in jeopardy. 

It’s not unusual for a nation’s bond market and currency to turn disorderly concurrently. Such a scenario for Treasuries and the dollar would place the Fed under the most pressure to tighten policy in decades. 

The iShares long-dated Treasury ETF (TLT) sank 4.1% this week, a painful reminder of how quickly losses can mount for a perceived low-risk Treasury bond. Treasuries, corporate bonds and fixed-income securities more generally are extraordinarily vulnerable to a painful bear market.

Meanwhile, high-yield bond risk premiums (spreads and CDS) remain near multi-year lows. 

This is in spite of looming Credit distress throughout the economy. Risk markets remain white-hot and financial conditions extraordinarily loose. Companies enjoy the easiest access to cheap finance, ensuring Credit stress, defaults and risk premiums remain well contained. 

Still, corporate Credit remains acutely vulnerable to a bout of risk aversion and a resulting tightening of financial conditions. We witnessed in March how quickly ETF outflows can manifest into marketplace illiquidity, dislocation and fear of systemic corporate defaults.

The iShares Emerging Market equities ETF (EEM) surged 5.8% this week to an all-time high, with a 22% gain since November 1st. Brazil’s Bovespa Index jumped 5.1% this week, with Mexico’s Bolsa up 6.0%. 

Major equities indices jumped 9.7% in South Korea, 9.2% in Chile, 6.0% in South African, 5.0% in Russia and 4.3% in Turkey. 

The global liquidity tsunami impacted virtually all markets, though some of the greatest effects were seen in many of the marginal markets most vulnerable to shifts in financial conditions. 

The global Bubble is today raging, but there is acute vulnerability to any unexpected risk aversion and tightening of financial conditions. 

No country faces a greater challenge than China in balancing the need to reduce stimulus against underlying acute fragility. 

After expanding Credit $500 billion monthly for most of 2020, Chinese officials will attempt to restore some degree of financial restraint. The risk of a financial accident in China in 2021 is reasonably high. 

Beijing postponed plans to get its Credit system in order as it confronted aggressive trade war tactics from the Trump administration. Officials then resorted to massive fiscal and monetary stimulus to counteract contractionary pandemic dynamics. 

Today, there’s excessive optimism regarding China’s economic recovery – and the soundness of its system more generally. Beijing is not oblivious to the perilous scope of China’s Bubble. 

Authorities will now cautiously attempt to impose restraint, a risky proposition for one of history’s great financial and economic Bubbles. I expect cracks in the corporate debt market and “small” bank sector to widen into more systemic issues in the event of heightened risk aversion and deleveraging. 

China’s apartment markets remain an accident in the making. The stability of China’s bloated banking system is an Issue 2021. 

It is now a dangerously synchronized global Bubble. Global developments – market, financial, economic and geopolitical – pose significant risk to the vulnerable U.S. Bubble. 

The general impression is that geopolitical tensions will ease with the new Biden administration taking control – especially with China. I’m skeptical that much will slow the evolving cold war between rival superpowers. Taiwan and the South China Sea much remain potential flashpoints for 2021.

But for now – and especially after this week’s developments - I remain more worried about domestic conflict than international. What an absolutely abhorrent start to the new year for our country. 

Wednesday’s spectacle was an appalling national nightmare. Was it a freak anomaly? 

The end of something – or more the beginning? 

As disturbing as Wednesday’s U.S. Capitol insurrection was, by evening I found myself trying to find reasons for hope. Would the debacle force some serious rethink? Would there be recognition that things had been pushed much too far? 

As a nation, through this disgusting episode of mayhem might we begin the challenge of national reconciliation. Could we come to a consensus that as a nation we need to tone down partisan rhetoric? 

Would Wednesday force the reassessment of efforts hell-bent on inciting anger – anger that burst into violence, desecration and even murder in our beloved Capitol Building. 

Our nation is today dangerously divided – and how this social crisis is handled is a key Issue 2021. 

Here, on Friday evening, I find myself less hopeful. 

The end of something or the beginning? 

Will the chaotic conclusion of the Trump presidency set in motion the healing process, or has something menacing been unleashed that will prove difficult to contain? 

Is the far-right fringe energized and emboldened? 

Can we keep the extremists from the right and left from clashing? Do we now face elevated risk of domestic terrorism?

How citizen Donald Trump handles quite difficult circumstances is, unfortunately, a major Issue 2021. Does he resolve to play a constructive role in national reconciliation, or does the famed “counterpuncher” coming out swinging madly at his adversaries? 

How gory does the unfolding civil war within the Republican party become?

I am left to hope for a much-needed easing of socials tensions – a pulling back from the precipice. There were over 300,000 new Covid cases today, with another 4,000 American deaths. 

We can be hopeful that with vaccinations we’ll be through the worst of this terrible pandemic within a few months. But how much worse will things become in the meantime? 

There are these more contagious virus variants, along with the possibility that virus mutations may at some point weaken vaccine efficacy. 

I worry about deepening scars – from the pandemic, from divisiveness, from all the hostility, and from waning faith in our institutions. I’m not happy to write another dark piece – in back-to-back weeks – 2020 and 2021 prospects. 

But I worry. We’re witnessing an increasingly combustible social tinderbox. I rather clearly see a fire starter. 

We’re a bursting Bubble away from severe societal crisis. And this could be the major Issue 2021. 

It’s tempting to focus on booming markets and the constructive role they will play in economic recovery and social healing. 

But it’s no coincidence that securities prices are going nuts as social stability increasingly fractures. Society today suffers the myriad deleterious effects from decades of dysfunctional finance and resulting Monetary Disorder. 

Meanwhile, the Fed responds feverishly to late-cycle market, economic and social fragility with Trillions. 

The inflationism I’ve been chronicling weekly for over two decades has turned desperate. 

This is a deeply troubling dynamic – a disaster in the making. 

The culmination of a crazy financial mania right in the face of deepening late-cycle economic and social distress. 

The worst-case Bubble scenario is, most regrettably, a momentous Issue 2021. 

I saw nothing but ominous confirmation of this troubling thesis during a chaotic first week of 2021: The Year of Acute Monetary Disorder and Fragility.

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