Global Ring of Fire
Doug Nolan
Money Market Fund Assets (MMFA) surged $70.5 billion last week to a record $6.111 TN.
MMFA have ballooned $1.553 TN, or 34.1%, since the Fed initiated its “tightening” cycle in March 2022.
In just over four years since the onset of the pandemic, MMFA have inflated $2.477 TN, or 68.2%.
April 5 – Bloomberg (Christopher Anstey):
“Former Treasury Secretary Lawrence Summers said that the surge in US payrolls in March illustrates that the Federal Reserve is well off in its estimate of where the neutral interest rate is, and cautioned against any move to lower rates in June.
‘This was a hot report that suggested that, if anything, the economy is re-accelerating,’ Summers said…
Alongside other factors including an ‘epic’ loosening in financial conditions, ‘it seems to me the evidence is overwhelming that the neutral rate is far higher than the Fed supposes,’ he said.”
“Epic” loosening in financial conditions, indeed.
I find the debate over the so-called “neutral rate” interesting, if not so relevant.
The critical debate goes undebated: Are we today in the fateful “terminal phase” of history’s greatest Bubble?
Affirmative, with today’s loose conditions and powerful speculative impulses having proved impervious to Fed rate hikes.
While extraordinary, today’s backdrop is not without precedent.
For students of market and economic history, there are too many alarming parallels to the waning days of the “Roaring Twenties.”
I again this week found my thoughts returning to the conclusion of Ben Bernanke’s November 2002 speech, “On Milton Friedman’s Ninetieth Birthday”:
“Let me end my talk by abusing slightly my status as an official representative of the Federal Reserve.
I would like to say to Milton and Anna: Regarding the Great Depression.
You’re right, we did it. We’re very sorry.
But thanks to you, we won’t do it again.”
“It follows, then, that the height of the recent boom and the depth of the depression are fundamentally the outcome of Federal Reserve credit extension.
The recent cycle may therefore properly be designated a central banking phenomenon.
The exaggerated character of the last boom and the slump is understandable only in the light of the superimposition of a central banking system upon our former system.
And an understanding of what was taking place in our banking system, largely as a consequence of the enactment of the Federal Reserve Act, is essential to an explanation of the causes of the depression.
If the recent cycle has proved so puzzling to so many students of its devious course and manifold phases, it is because the full effects of the creation and operation of this central banking system upon the commercial banks have not been widely nor adequately understood; nor, furthermore, have the influences of the changing structure of the American banking system upon the structure of production been fully realized.”
- Banking and the Business Cycle, C.A. Philips, Ph.D., T.F. McManus, Ph.D. and R.W. Nelson, Ph.D., 1937
Our understanding of the most momentous financial and economic occurrence of the past century has been terribly undermined over the decades.
Great contemporaneous insights and analyses of the causes of the Great Depression were repudiated by the historical revisionists.
Rather than recognizing the major impact Federal Reserve operations exerted over the historic “Roaring Twenties” Bubble period, revisionists extraordinaire Friedman and Bernanke turned history on its head by blaming the collapse on Fed tightening and their failure to print enough money.
From Bernanke’s speech:
“For the early Depression era, Friedman and Schwartz identified at least four distinct episodes...
Three are tightenings of policy…
The first episode analyzed by Friedman and Schwartz was the deliberate tightening of monetary policy that began in the spring of 1928 and continued until the stock market crash of October 1929.
This policy tightening occurred in conditions that we would not today normally consider conducive to tighter money: As Friedman and Schwartz noted, the business-cycle trough had only just been reached at the end of 1927…, commodity prices were declining, and there was not the slightest hint of inflation.
Why then did the Federal Reserve tighten in early 1928?
A principal reason was the Board's ongoing concern about speculation on Wall Street.”
“As Friedman and Schwartz noted, ‘by July [1928], the discount rate had been raised in New York to 5%, the highest since 1921, and the System’s holdings of government securities had been reduced to a level of over $600 million at the end of 1927 to $210 million by August 1928, despite an outflow of gold.’
Hence this period represents a tightening in monetary policy not related to the current state of output and prices -- a monetary policy ‘innovation,’ in today's statistical jargon.”
At about 5%, is monetary policy tight today?
Was a 5% rate tight in 1929?
No and no, with both periods notable for exceptionally loose conditions prevailing in the face of Fed tightening measures.
Importantly, prolonged Bubble inflation ensures powerful momentum in Credit expansion and speculative excess, which largely sidesteps tightening measures that would be restrictive in all other environments.
Credit growth remained strong throughout much of 1929, though the expansion was dominated by broker call loans (for speculation) and real estate lending.
For the current Bubble, Credit excess has persisted, dominated by Treasury debt and leveraged speculation (i.e., “repo” financed “basis trades” and “carry trades”).
There should be no doubt that system stability would have been safeguarded by popping the current Bubble years ago.
Bernanke pillories the “Roaring Twenties” analysts (“Bubble poppers”) with similarly sound analytical frameworks.
Prolonged Credit and speculative excess and resulting deep structural maladjustment were chiefly responsible for the crash and subsequent Great Depression.
At its September 3, 1929, closing high, the Dow enjoyed a y-t-d gain of 27%.
Instead of pointing blame for the crash on 1928/29 “tightening” measures, look instead to the Fed’s aggressive 1927 (NY Fed Pres. Benjamin Strong’s “coup de whiskey”) late cycle stimulus that unleashed perilous “Terminal Phase” excess.
From January 1, 1929, to the cycle peak September 3, 1929, high, the Dow Jones Index surged 145%.
I’m rehashing important history because these two cycles seem to have more in common by the month.
As the above “Banking and Business Cycle” quote notes, “the full effects of the creation and operation of this central banking system upon the commercial banks have not been widely nor adequately understood.”
For today’s Bubble cycle, the full effects of the contemporary Fed’s monetary tools on market-based finance are not understood at all.
History’s greatest Bubble does not inflate, if not for trillions of QE, zero rates, and myriad liquidity support mechanisms.
Federal Reserve inflationist policies have made unprecedented peacetime 7%-to-GDP federal deficits possible, spending that has been instrumental in inflating corporate earnings and household incomes.
Today’s unmatched speculative leverage is only possible because of the high degree of confidence in the Fed’s liquidity backstop that developed over repeated market bailouts.
And as the dominant global central bank, global stimulus measures and resulting Bubbles have their roots in Federal Reserve policy experimentation and U.S. financial innovation.
If there’s no Ben Bernanke, there is no Mario Draghi or Haruhiko Kuroda.
And without these three inflationists, I seriously doubt China’s Bubble inflates for so many years.
The Fed’s ongoing accommodation of leveraged speculation ensured “carry trades” and such engulfed the entire world (every nook and cranny).
In post blowout March payrolls data punditry, there was more talk of U.S. exceptionalism.
I don’t want to dismiss our great nation’s many attributes.
AI and tech notwithstanding, we definitely lead the world in our capacity to sustain loose financial conditions.
No country can compete in terms of financial innovation.
And with the world’s reserve currency, we have a unique capacity to get away with policy and financial transgressions – for decades.
U.S. “exceptionalism” is perilous.
Only a Fed tightening of financial conditions would have restrained Bubble excess before it was too late.
Instead, late-cycle excess took control – foolhardy deficit spending, levered speculation, private Credit, consumer “buy now, pay later,” manic stock and options trading, etc.
And late-cycle euphoria and boundless speculative finance now unite with AI, a spending black hole open to the wildest of imaginations.
Parallels to 1929 are not to be dismissed.
A Friday Evening Bloomberg headline:
“Extreme Market Swings Dominate as Hot Economy, Oil Feed Anxiety.”
It had the feel of an important week.
March’s 303k payrolls gain solidifies the economic overheating thesis, while Powell only reinforced the Fed’s misguided precommitment to rate cuts.
Cracks began to surface this week.
Fed Governor Michelle Bowman:
“While it is not my baseline outlook, I continue to see the risk that at a future meeting we may need to increase the policy rate further should progress on inflation stall or even reverse.”
Minneapolis Fed President Neel Kashkari:
“If we continue to see inflation moving sideways, then that would make me question whether we need to do those rate cuts at all.
There’s a lot of momentum in the economy right now.”
The bullish narrative has been so deeply embraced.
From the above Bloomberg article:
“Bolstered by optimism that the Fed will be able to bring inflation toward its 2% target without snuffing out growth, $176 billion of fresh money was poured into fixed income and equity ETFs in the first quarter, more than doubled from a year ago.”
From Monday’s high to Tuesday’s trading low, the Nasdaq100 (NDX) dropped 2.1%.
From Tuesday’s low to Thursday’s high, the NDX then rallied 2.0%, only to reverse 2.6% lower by Thursday’s close.
And from Thursday’s close to intraday Friday highs, the NDX rallied 1.8%.
Coming two weeks ahead of monthly option expirations, payrolls Friday can be pivot sessions for derivatives positioning.
This is especially the case when market vulnerability has triggered heavy options hedging and speculating activity.
A strong payrolls report had the potential to hammer bonds, with higher yields and “higher for longer” policy rates bruising bullish sentiment (and highly extended stock prices).
And while bond yields jumped nine bps Friday (up 20bps for the week) to a four-month high of 4.40%, there was no carryover from Thursday’s equities selloff.
When selling failed to materialize Friday morning, stocks (especially big tech) caught fire, surely fueled by short covering and the unwind of derivative hedges and bearish bets.
Curiously, after jumping from 14.33 to 16.35 in volatile Thursday trading, the VIX (equities volatility) Index retreated little during Friday’s rally (closing week at 16.03).
There was some notable volatility in high yield and EM CDS, “periphery” indicators where one would expect incipient risk aversion to surface.
But, at the end of the day (week), loose conditions prevailed.
Gold dropped $10 immediately upon the release of the strong payrolls data – as NDX futures fell about 0.5%.
And both gold and the NDX wavered for about an hour, before concurrently surging higher.
For the day, the NDX rose 1.3%, while Gold surged $39, or 1.7%, to trade to a record high $2,330.
For the week, Gold jumped $100, or 4.5%, with Silver surging $2.51, or 10.1%, to $27.48.
The precious metals corroborate the precariously loose financial conditions thesis.
I view the huge growth in money market fund assets as an inflationary consequence of levered speculation, in particular the huge expansion of “repo” securities finance.
I see “basis trade” leverage as a major source of liquidity creation, along with equities derivatives-related leverage.
I suspect huge leverage is associated with the big technology stocks, indices, and derivatives (Nvidia, “mag 7,” NDX, SOX), with speculative melt-up dynamics a major contributor to marketplace liquidity excess.
The Bloomberg Commodities Index jumped 3.4% this week to a five-month high, posting the strongest weekly gain since last June.
Crude gained another 4.5% to a six-month high $86.91.
Copper surged 5.7% this week to a 14-month high.
Platinum rose 2.1%.
Lead jumped 6.0%, Nickel 7.1%, Tin 4.6%, and Zinc 8.3%
In an over-liquefied inflationary environment, the precious metals, and commodities more generally, are displaying their store of wealth attributes.
Are their recent strong gains foreshadowing trouble for financial assets?
It’s worth noting that the currencies were relatively well-behaved this week.
I suspect good behavior will be short-lived.
With markets on intervention watch, the yen (down 0.18%) and the renminbi (down 0.15%) were still under modest pressure.
The relative stability of two acutely vulnerable currencies likely underpinned global markets this week.
Calm before the storm.
I anticipate heightened market volatility – stocks, bonds, and the currencies.
The big tech stocks are one massive Crowded Trade.
The proliferation of option trading (call writing strategies in particular) risks the biggest “Volmageddon” yet.
Bond market deleveraging would really catch the market by surprise.
And lurking out there is a disorderly unwind of global “carry trade” leverage, a risk that rapidly escalates when currency trading turns disorderly.
Overheated U.S. markets, Credit and economic activity raise the odds of a disorderly rise in bond yields.
Simultaneous yen and Japanese government bonds selloffs would pose quite a challenge for the BOJ.
A strong dollar would elevate the risk of destabilizing capital flight out of China.
China sovereign CDS rose four this week to 74 bps, the high since early November.
Chinese bank CDS were moderately higher again this week to five-month highs.
New York was rocked Friday by the most powerful earthquake (4.8) in more than a century.
Taiwan’s Monday quake was the strongest (7.4) in 25 years.
On many levels, the world seems a shakier place.
As for global markets, the dogs were looking anxious this week.
Initial little tremors and sparks have me focused on fault lines and the Global Ring of Fire.
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