Vigilantes Mobilizing
Doug Nolan
Tuesday’s pivotal election muddies the analysis.
Clearly, however, the Treasury market is under meaningful pressure.
Ten-year Treasury yields jumped 14 bps this week to a four-month high of 4.38%.
Yields are up 76 bps since September 17th, the day before the Fed slashed rates 50 bps – with yields now 50 bps higher in 2024.
The MOVE (bond market volatility) Index rose another five this week, to a one-year high of 133.
The rates market closed Friday pricing a 3.65% December 2025 Fed funds rate – up another 13 bps this week and 70 bps higher since the end of September.
Friday trading was noteworthy.
Ten-year Treasury yields rose to 4.31% just ahead of the release of October Non-Farm Payrolls data.
Then, they quickly sank to 4.22% following the much weaker-than-expected 12,000 jobs added.
But yields then reversed and did a bear market 16 bps grind higher throughout the day, to close the session at the highest yield since July 1st.
It’s tempting to just write off poor Treasuries performance to pre-election positioning.
But there’s clearly much more to current market dynamics than election uncertainty.
For one, it’s global.
Looks important.
Vigilantes Mobilizing.
October 30 – Bloomberg (Joe Mayes, Alex Wickham and Ellen Milligan):
“Chancellor of the Exchequer Rachel Reeves unveiled £40 billion ($51.9bn) of tax rises and ramped up borrowing, a dramatic move to meet Labour’s pledge to ‘rebuild’ the UK that still risks disappointing voters.
Reeves put the tax burden on course for a postwar high with hikes impacting businesses and the wealthy in particular, pointing the finger at her Conservative predecessor for leaving a fiscal black hole she said had undermined Labour’s plans.”
UK 10-year gilt yields surged a notable 21 bps this week, to a one-year high of 4.45% - after trading Thursday to an intraday high of 4.53%.
Gilt yields have surged 91 bps so far this year, with yields now above October 2022 crisis highs.
UK two-year yields spiked 33 bps in seven sessions, to a five-month high of 4.43%.
Other debt and deficit problem children didn’t fare that much better.
Italian yields jumped 17 bps to 3.68%, with Greek yields up 14 bps to 3.31%.
French yields rose 12 bps to an almost four-month high 3.16%.
The emerging markets are certainly not without their own issues.
Local currency yields were up almost across the board this week.
Turkish 10-year yields surged 32 bps this week to 28.46%.
Yields jumped 30 bps in Brazil to a 19-month high of 12.98%, 14 bps in Mexico to an almost five-month high of 10.20%, and 17 bps in Peru to a three-month high of 6.79%.
Yields were 18 bps higher in Poland to a one-year high of 5.93% - with a one-month yield spike of 70 bps.
Interestingly, dollar-denominated EM bonds were not spared.
Yields surged 31 bps this week in Panama (4-month high 7.03%), 31 bps in Colombia (5-mn high 7.65%), 23 bps in Mexico (1-yr high 6.29%), 15 bps in Brazil (3-mn high 6.30%), 12 bps in Chile (3-mn high 5.08%), and 10 bps in Peru (4-mn high 5.47%).
From September lows, yields have spiked 107 bps in Panama, 90 bps in Colombia, 81 bps in Mexico, 67 bps in Peru, 65 bps in Chile, and 62 bps in Brazil.
Key EM currencies were under pressure this week.
The Brazilian real declined 2.77%, the Colombian peso 2.44%, the Mexican peso 1.47%, and the Chilean peso 1.45%.
The Brazilian real, down 17.26% y-t-d versus the dollar, closed the week right at the record from pandemic crisis May 2020.
Down 16.33% y-t-d, the Mexican peso finished the week at the lowest level since September 2022.
Might the weakness in key EM bonds and currencies be associated with ongoing yen “carry trade” deleveraging?
The August yen “carry trade” blowup was quickly followed by a dovish Powell in Jackson Hole, and then in September by a 50 bps Fed cut.
It’s likely that expectations of an aggressive Federal Reserve easing cycle initially mitigated yen “carry trade” unwind selling pressure.
But with Treasury yields reversing sharply in October and the market scaling back Fed rate cut expectations, it appears deleveraging has gained momentum.
Global bond markets trade as if deleveraging has taken hold.
Back in early August, pressure on both the yen “carry trade” and AI/tech Bubbles risked a more systemic de-risking/deleveraging.
It’s worth noting that the Semiconductor Index (SOX) dropped 4.1% this week, trading Thursday at a six-week low.
Micron Technology was down 7.6% this week, with Advanced Micro Devices sinking 9.2%.
Nvidia fell 4.3%, Microsoft 4.2%, Apple 3.7%, and Qualcomm 2.9%.
November 1 – Financial Times (Richard Waters and Tim Bradshaw):
“Big Tech’s capital spending is on track to surpass $200bn this year and rise even further in 2025, as anxiety grows on Wall Street about the returns on soaring investment in artificial intelligence.
The four biggest US internet groups — Microsoft, Meta, Amazon and Google’s parent Alphabet — this week offered investors brief glimpses into the benefits they are seeing from their headlong rush into generative AI, arguing that it was boosting the performance of core services and helping to hold down operating costs...
Capital expenditure at the four biggest hyperscalers grew more than 62% on the year before, to about $60bn during the quarter…
Meta and Amazon were among those to point to further increases in spending next year.”
The manic AI/tech Bubble is today acutely vulnerable to any tightening of financial conditions.
And while the Treasury market has been under pressure, so far there has been little to indicate deleveraging and associated waning liquidity in the broader U.S. debt market.
Investment-grade and high yield spreads (to Treasuries) remain near multi-year lows (high yield spreads narrowed this week).
Corporate debt issuance, leveraged lending, and “private Credit” all remain overheated.
Emerging Market CDS prices increased three this week to 170 bps – near highs since mid-August.
At this point, it has the feel of rising global yields and nascent de-leveraging beginning to pressure the “periphery.”
From the “periphery and core” analytical framework, we could expect some initial boost to the “core” (U.S. Credit market) from risk-aversion at the “periphery.”
But make no mistake, the “core” is today extraordinarily vulnerable.
Loose conditions and overheated Credit are stoking overheating risks.
And there’s also the issue of elections on Tuesday.
One way or the other, massive deficits as far as the eye can see.
And when things start to go awry, there’s certainly plenty of speculative leverage to cause systemic grief.
November 1 – Bloomberg Intelligence (Brian Meehan):
“Leveraged net shorts of Treasury futures surged to historic levels yet again to $1.15 trillion, a jump of almost 50% this year, as hedge funds pile into the basis trade.
While repo funding markets have been steady, the massively leveraged trade is larger by $707 billion, or 160%, than at the March 2020 seizure – meaning the Fed would likely need to bail out traders again to unwind those positions at the same time.”
Below are excerpts from my presentation for the McAlvany Wealth Management Tactical Short Q3 recap conference call:
We live today in a world of seemingly stark inconsistencies – confounding incongruence.
Record stock prices, unprecedented household wealth, and incredible technological innovation.
At the same time, society is resentful, deeply divided, and insecure.
Meanwhile, the geopolitical environment is extremely alarming.
In its third year, the war in Ukraine has turned increasingly dangerous.
Ukraine occupies a small Russian enclave, while expanding drone attacks across Russia.
The West is considering allowing Ukraine to use its weapons to strike deep into Russia, as Putin uses revisions to Russia’s nuclear doctrine as a direct threat to the U.S. Russia has been firing North Korean missiles, and now Kim Jong-Un has sent thousands of troops to fight for Putin.
The conflict in Gaza has now engulfed Lebanon – and risks consuming the entire Middle East.
In alarming escalation, Israel and Iran have been in tit-for-tat missile strike retaliation.
And a couple weeks back, China’s military encircled Taiwan, stating openly that it was war gaming for a blockade scenario.
Just this week, Beijing threatened to retaliate if U.S. arms shipments to Taiwan continue.
It’s only a matter of time until China moves to fulfill its often-stated top priority – the reunification of Taiwan with the Chinese motherland.
It is commonly viewed as the most dangerous geopolitical backdrop since World War II.
Yet stocks are at all-time highs, and market optimism remains at extremes.
And incredible innovation indeed underpins the AI/technology mania and scientific advancement.
What gives?
From my analytical framework, these incongruencies have a common thread: They’re all consistent with late-cycle dynamics – an incredible endgame for a historic multi-decade super cycle.
During last quarter’s call, I discussed the parallels between the current environment and the “Roaring Twenties.”
Both periods were remarkable for a confluence of monumental technological advancement, financial innovation, credit and speculative excess, and catastrophic boom and bust dynamics.
The wedding of late-cycle financial excess and momentous technological advancement pushed the cycle to fateful extremes – even as mounting financial, economic, and geopolitical risks had turned conspicuous.
When reading the history of the late-twenties, one ponders how it was possible for bullish stock speculators to disregard so much – egregious excess, profound social change, inequality and cultural angst here in the U.S.; post-hyperinflation economic, social and political turmoil in Germany; the rise of authoritarianism and fascism in Europe; post-revolution instability and the rise of communism in Russia; social and political tumult in Latin America and the Middle East; civil war in China – for starters.
Like today, wild speculative excess and mounting social, political, and geopolitical turmoil were not coincidental – they were instead tragically interconnected late-cycle phenomena.
I want to again highlight a theoretical framework that helps bring some clarity to today’s confounding backdrop.
Bubbles are mechanisms of wealth redistribution and destruction – with detrimental consequences for social and geopolitical stability.
Boom periods engender perceptions of an expanding global pie.
Cooperation, integration, and alliances are viewed as mutually beneficial.
But late in the cycle, perceptions shift.
Many see the pie stagnant or shrinking.
A zero-sum game mentality dominates.
Insecurity, animosity, disintegration, fraught alliances, and conflict take hold.
It bears repeating: Things turn crazy at the end of cycles.
Years and even decades of credit expansion, speculative bubbles, and government-led bailouts conspire for parabolic “blow off” surges in risky late-cycle credit inflations and market manias.
Meanwhile, years of destabilizing price inflation and increasingly conspicuous wealth redistribution push societies and nations to the breaking point.
These dynamics foment complex late-cycle dynamics – highlighted by manic speculative blowoffs concurrent with rapid degradation in both the social fabric and existing world order.
Late-cycle bubbles exhibit peculiar behavior.
As we’ve witnessed, once bubbles have inflated to precarious extremes, confidence in the marketplace only solidifies that central banks and governments will act early and forcefully to thwart crisis dynamics.
Such a posture foments instability and volatility, as market sentiment pivots from alarm over bursting bubble risk to manic affirmation that inflating markets enjoy a foolproof backstop.
This is precisely the dynamic witnessed in August.
On the 5th, at intraday trading lows, the S&P500 was down 4.3%, the Nasdaq100 5.5%, and the KBW Bank Index 5.0%.
The VIX equities volatility index spiked above 60 for the first time since the 2020 pandemic crisis.
Japan’s Nikkei 225 stock index that day sank 12.4%, capping a three-session collapse of almost 20%.
South Korea’s Kospi Index dropped 9%, as intense de-risking erupted across markets globally.
Bitcoin was down almost 14% intraday.
I believe we’ll look back on that erratic market session as portending trouble ahead – a warning of mounting bubble fragility.
In particular, August 5th exposed acute vulnerability for two historic bubbles – the yen “carry trade” and AI/tech bubbles.
This past March, the Bank of Japan raised its policy rate to 10 bps, ending a seven-year experiment with negative rates.
Japanese rates had not been above 10 bps since 2008 – and hadn’t surpassed 50 bps all the way back to 1995.
Literally for decades, artificially low rates have incentivized borrowing cheap in Japan for leveraged “carry trade” speculations in higher-yielding instruments across the globe.
Between speculative leverage and Japanese institutional and retail flows, trillions have flowed freely from Japan.
An abrupt reversal of this torrent would be highly destabilizing across the world of finance.
With domestic inflation and imbalances having pushed the BOJ to commence policy normalization, currency markets were understandably on edge.
The dollar/yen spiked to a multi-decade high of 162 on July 10th, before reversing sharply lower.
Over the next four weeks, the yen would rally 12%, with the dollar/yen trading at an intraday low below 142 on August 5th.
A disorderly unwind of yen “carry trade” leverage spurred intense market instability and fears of broadening de-risking/deleveraging.
From last November lows to July highs, the Semiconductor Index surged 86%, and the Nasdaq100 rose 45%.
Nothing short of a historic mania and speculative melt-up took hold, led by AI, the semiconductor companies, and the “magnificent seven” tech behemoths – and later to widen throughout tech, the financials and utilities, along with the broader market.
We can assume enormous speculative leverage has accumulated – margin debt, hedge fund leverage and, importantly, embedded leverage in derivatives.
At August 5th lows, the Semiconductor Index and Nasdaq100 had sunk 28% and 15% from July highs.
With the unwinding of yen “carry trade” and technology stock speculative leverage, markets were at the cusp of a systemic de-risking/deleveraging event.
This explains the VIX Index’s spike to multi-year highs.
Wall Street was close to panicking on that fifth day of August.
According to the narrative at the time, the economy was in trouble – and after waiting too long, the Federal Reserve must now respond forcefully.
Cries immediately rang out for the Fed to aggressively slash rates, with some even pleading for an emergency inter-meeting cut.
Market relief was provided by timely comments from the Bank of Japan’s influential deputy governor Shinichi Uchida, who said: “We won’t raise interest rates when financial markets are unstable.”
Japan’s Nikkei Index rallied 10% on August 6th, as global markets quickly stabilized.
A couple weeks later, from dovish Chair Powell at Jackson Hole, markets received the news they had clamored for: “The time has come for policy to adjust.
The direction of travel is clear…”
And in September, the Fed slashed rates 50 bps.
Policymakers responded exactly as speculative markets assumed.
Especially in a backdrop of acute fragility, markets count on central banks to respond swiftly and forcefully to nascent instability.
And this key dynamic underpins extreme risk-embracement and other late-cycle speculative excess, in the process extending the lives of historic bubbles.
Repeated interventions and bailouts over the course of the cycle alter market perceptions, structure, and function.
Over time, markets turn increasingly dysfunctional – with mounting excess and imbalances promising only more policy stimulus.
Risks can be ignored.
Market dynamics become increasingly preoccupied with chasing trading opportunities from recurring short squeezes and the unwind of bearish hedges.
And as this speculative market dynamic is rewarded by Federal Reserve behavior, it only grows in dominance.
After trading at 4.60% in late May, 10-year Treasury yields fell to a 15-month low of 3.62% in the session before the Fed’s September meeting.
The S&P500 enjoyed a y-t-d return of 20%, with the Broker/Dealer Index returning 24%.
Most market risk premiums traded to the lowest levels since the Fed commenced its rate-hiking cycle.
In short, the Fed aggressively eased monetary policy, with financial conditions exceptionally loose.
Sustaining bubbles is risky business – with systemic risk rising exponentially late in the cycle.
The S&P500 recovered to trade to new record highs in September, as bullish exuberance reached extremes.
A record $500 billion flowed into ETFs during the quarter.
There was a record $600 billion of global debt issuance in September, with U.S. investment-grade bond sales surging to a record $171 billion.
Another $128 billion of leveraged loan deals were launched – the first time to surpass $100 billion.
With two months to go, asset-backed securities have already posted the strongest annual sales since the mortgage finance bubble.
Sales of collateralized loan obligations have also boomed.
“Feeding frenzy” is an apt description of happenings in the bubbling “private-credit” universe – in what is essentially corporate America’s subprime boom.
A key risk premium, corporate investment-grade spreads-to-Treasuries, recently traded to the lowest level since 2005.
That period, at the heart of the mortgage finance bubble era, was similarly notable for liquidity abundance-fueled excess.
I want to stress an important point: You just don’t see this degree of inflationary market excess without some underlying monetary dislocation.
I’ll highlight that money market fund assets surged $360 billion during the quarter, or 23% annualized.
Money fund assets have inflated $1.9 TN, or 42%, just since the Fed began its “tightening cycle” in March 2022 - and an incredible $2.9 TN, or 79%, since the start of the pandemic.
And this historic monetary inflation runs unabated.
Money fund assets have inflated $374 billion, or 26% annualized, over the past 12 weeks.
I believe a surge in money market liquidity emanates from the “repo” market’s funding of leveraged speculation.
I have written about this dynamic - and discussed it recently at the McAlvany Wealth Management client conference.
This is epic monetary inflation flowing chiefly from the expansion of speculative credit in the money markets – short-term “repo” market funding of levered Treasury “basis trades” and more general fixed-income “carry trade” leverage.
I liken the expansion of money market deposits to fractional reserve banking and the bank “deposit multiplier” – but without reserve requirement constraints.
In the late-nineties, I referred to this dynamic as an “infinite multiplier” – I just never imagined the “repo” market and money fund deposits would inflate to surpass $6.5 TN.
I closely monitored this dynamic during the late-nineties bubble period, and then again throughout the mortgage finance bubble.
But excesses during today’s most protracted global government finance bubble have reached an entirely new level – in scope and duration, along with deeply corrosive effects on market, financial and economic structures.
The only period of comparable excess and maladjustment would be the fateful “Roaring Twenties” bubble experience.
It’s more important today than ever to recognize that policymaker interventions – especially here so late in the cycle – spur only more destabilizing excess – speculation and leverage, high-risk lending, and resulting deeper financial, economic, and social maladjustment.
There’s just no escaping this harsh bubble reality.
And it’s reached the point where consequences include historic market and AI manias, perpetual fiscal deficits in the $2 TN range, a trillion-dollar plus highly levered “basis trade,” incendiary social angst, and geopolitical turmoil.
Nothing good comes from extending “terminal phase excess.”
And it’s all consistent with the endgame for a historic multi-decade super-cycle - only too fitting that the greatest bubble in human history concludes with a prolonged period of the craziest excess and wildest instability.
After all, policymakers around the world are doing whatever they think it takes to hold bubble collapses at bay.
Japan continues to defer policy normalization.
An increasingly desperate Beijing has succumbed to “whatever it takes” reflationary measures.
The Fed ignores precariously loose conditions and speculative bubbles.
The ECB aggressively slashes rates.
Meanwhile, all these measures promote late-cycle “terminal phase” parabolic debt growth – government and private sector, along with a fateful deluge of speculative financial credit.
“How will this all end?”
I wish I knew.
There are ample potential catalysts.
Normally functioning markets would have brought such egregious excess to a conclusion years ago.
But even irrepressible bubbles eventually succumb.
Markets have been afflicted with the “frog in the pot” syndrome when it comes to geopolitical risks.
Does the Middle East erupt into a more globalized conflict?
Could the Ukraine war escalate into a nuclear crisis?
What’s North Korea up to?
Is China preparing to tighten the noose on Taiwan – and how would the U.S. respond?
The new and formidable “axis of evil” – China, Russia, North Korea, and Iran – is determined to capsize the U.S.-led global order.
I fear we’ve entered a highly unstable period of unending conflict and crises.
Yet markets have remained comfortable disregarding mounting geopolitical risk.
This extraordinary complacency has a clear source: Federal Reserve and global central bank market backstops.
But we’re now seeing a dangerous escalation of geopolitical risk, concurrent with unappreciated issues with policymaker backstops.
Ten-year Treasury yields surged 52 bps this month.
Yields on benchmark MBS securities are up 82 bps.
At yesterday’s record price, gold was up $140, or 5.3%, for the month to $2,775, while silver was up 10% to $34.45.
The Atlanta Fed GDPNow forecast of current growth has increased to 3.4% - and yesterday we learned that Q3 personal consumption jumped to 3.7%.
Overheating risks are increasing.
And especially with China’s newfound determination to reflate, the likelihood of upside inflation surprises increases.
Market complacency also applies to inflation risk.
For starters, our federal government ran a $1.8 TN deficit last year, or almost 7% of GDP.
Whether it’s a Trump or Harris administration, most analysts believe the deficit only grows from here.
There are reasonable scenarios where it spirals out of control.
Legendary hedge fund operator Paul Tudor Jones last week stated the issue concisely:
“We are going to be broke really quickly unless we get serious about dealing with our spending issues.”
I was reminded of Ernest Hemingway’s two paths to bankruptcy: gradually and suddenly.
I believe inflationary psychology throughout the economy has become more deeply rooted than Wall Street and the Fed are willing to admit.
At a 4.1% unemployment rate, labor markets remain tight.
Labor unions are emboldened, as again confirmed by Boeing’s spurned offer of a 35% pay hike to end its strike.
Companies have learned they can pass along higher costs.
Meanwhile, I believe climate change will present growing inflationary risks.
We’ve already experienced rising food costs, along with incredible inflation in various types of insurance.
And we saw just weeks back the scope of destruction wrought from back-to-back hurricanes Helene and Milton.
There will be considerable spending on clean-up and rebuilding, economic stimulus that underpins the forces of inflation.
There will also be greater spending on emergency preparation, as large swaths of the country face growing exposures to extreme weather events.
Over the past two years, U.S. and global inflationary pressures have been somewhat mitigated by disinflationary forces out of China.
With the ongoing deflation of China’s historic apartment bubble, stimulus measures were buckets dumped into an ocean.
But this summer, bubble deflation entered a dangerous acceleration phase.
A crisis of confidence was taking hold.
Xi Jinping has hit the reflation panic button: hundreds of billions for the stock market, hundreds more for the deeply troubled local government sector, many hundreds to try to stabilize apartment markets.
What’s more, Beijing has essentially promised to spend whatever it takes to reach growth targets.
A Reuters article this week placed Beijing’s stimulus at $1.4 TN.
This is for a system locked in massive credit expansion – upwards of $5 TN annually.
Considering the powerful forces of bubble deflation, I appreciate the view that even the grand scope of the latest stimulus barrage won’t be enough to turn the tide.
But this is almost beside the point.
I expect Xi Jinping to throw everything at a now open-ended reflation effort.
He’s highly motivated.
Collapse would be blamed on him and his communist party, while Xi’s global superpower ambitions would crumble right along with China’s global financial and economic standings.
Xi made telling comments last week when meeting with Putin.
He said:
“At present, the world is going through changes unseen in a hundred years, the international situation is intertwined with chaos.”
A deluded Xi Jinping will view mammoth reflationary efforts as fundamental to ensuring chaos doesn’t engulf China.
And mounting domestic risks, I fear, raise the odds of Beijing diverting attention with the hastening of Taiwan reunification efforts.
We see the geopolitical backdrop underpinning price pressures for many things.
There are already added costs for shipping that avoids the Red Sea, while Russia has been sinking grain ships in the Black Sea – as examples.
An upsurge in trade protectionism and tariffs would impact pricing, availability, and supply chains for key goods and resources.
We expect the acceleration of de-globalization to come with heightened inflation risks.
While the risk of another inflationary spike is not remote, I’m focused on the potential for a more moderate uptick in inflation that would put the Federal Reserve on its heels.
Importantly, mounting bond market deficit and supply concerns intensify if the Fed is forced to put its easing cycle on ice.
I believe global bond markets have finally begun to wake up to the problem.
Recall that bond deleveraging and a spike in yields brought down UK Prime Minister Liz Truss and forced belt tightening in October 2022.
UK yields surged another 18 bps last week and another 26 this week to trade to 4.50% today, surpassing the 2022 crisis peak.
More recently, markets nervously eye French politics and looming budget battles.
French yield spreads to German bunds recently touched the widest levels since the 2012 European bond crisis.
Italian spreads widened to 2021 levels.
And Japanese JGB yields are back to 1%, near 13-year highs.
From my analytical perspective, the highly levered Treasury market today poses a major risk to global market stability.
The “basis trade” is said to easily surpass $1 TN, and I suspect this is only a segment of speculative leverage that permeates the entire U.S. credit market – Treasuries, corporate bonds, muni bonds, MBS, ABS, private credit, leveraged loans, structured finance, and derivatives.
Let’s return to the VIX Index’s August 5th spike to 60. De-risking/deleveraging today creates a momentous risk.
There are scores of bubbles globally, interconnected across markets and between nations and regions.
In early August, the unwind of “yen carry” leverage pressured the AI/tech Bubble.
These two faltering bubbles were at the cusp of triggering a systemic de-risking/deleveraging dynamic.
Importantly, a more systemic deleveraging would spawn market liquidity issues, widening risk premiums, and general pressure on Credit market leverage – the extremely levered “basis trade” in particular.
I’ll reiterate the endgame thesis.
Sure, central bankers could again bail out speculative markets.
But all that would accomplish is another wave of speculative excess and more problematic leverage.
And keep in mind that once markets succumb to late-cycle manic excess, prolonging the bubble comes at a steep cost. Crazy turns only crazier.
The tech mania has inflated to the point where trillions are to be spent on data centers, semiconductor fab plants, energy infrastructure, old decommissioned nuclear reactors, and all things AI.
Meanwhile, the proliferation of uneconomic businesses runs unabated.
Corporate and consumer debt growth runs unabated.
Washington deficit spending – unabated.
A large and expanding swath of the U.S. bubble economy – certainly including the AI mania – is addicted to loose conditions.
The Fed concluded its so-called “tightening cycle” without financial conditions actually tightening.
This only raised the odds that it will be market de-risking/deleveraging that unleashes highly destabilizing tightening dynamics.
These days, I worry mightily about economic structure and the vulnerability to market dislocation, deleveraging, tighter conditions, and illiquidity.
Years of loose finance, credit excess and bubble markets have nurtured an economic structure acutely vulnerable to market instability and a resulting interruption in credit expansion.
We have a pivotal election next Tuesday.
In last Friday’s CBB, I highlighted insight from hedge fund manager Paul Tudor Jones.
He referred to November 5th as the macro analysis “super bowl.”
In analysis harmonious with my analytical framework, Tudor Jones sees the election as a potential catalyst for sudden bond market reassessment.
He warns of the potential for a so-called “Minsky moment” – that “financial crises percolate for years.
But they blow up in weeks.”
I’m in complete agreement with his view that federal debt growth is unsustainable – and that we are at “an incredible moment in U.S. history.”
I won’t venture a guess on who our next President will be or over the composition of party control of Congress.
But the bond market has shown vulnerability to what has been incredibly imprudent tax cut and spending proposals from both Trump and Harris.
For me, the spectacle of this election cycle pushed “deficits don’t matter” to precarious extremes – perhaps crossing market “red lines.”
Such profligacy has been a dangerous consequence of repeated Fed market bailouts and the resulting subversion of market discipline.
My basic assumption throughout this most protracted credit bubble was that market discipline would eventually win the day.
It has been an incredibly long wait.
And we all know the pitfalls of asserting “this time is different.”
But I believe it’s telling that 10-year Treasury yields have jumped 65 bps and MBS yields 102 bps since the Fed slashed rates 50 bps in September.
Gold and silver prices have surged 6.6% and 6.4% since the Fed, increasing y-t-d gains to 33% and 37%.
Something’s definitely up.
I’ve intensively analyzed this bubble period now for over three decades – and have been repeatedly astounded by the scope of central bank and government inflationary measures, market interventions, and bailouts.
That debt markets would so embrace open-ended inflationism has been mind-boggling.
I’ve long believed a point would be reached where the bond market begins to respond negatively to Federal Reserve loosening measures.
And such an occurrence would likely mark a critical juncture for the cycle – a point where the Fed would finally be forced to think twice before again calling upon its inflationary toolbox.
There are a few things we understand today with confidence.
At this very late cycle phase, the scope of excess is off the charts.
Speculative leverage is today unprecedented.
This ensures that the next serious bout of de-risking/deleveraging and market illiquidity will place excruciating pressure on the Fed and central bank community to restart QE to meet their “buyer of last resort” obligation.
We also know that inflation remains elevated, with myriad risks both domestic and global.
It is this backdrop that shapes my view of the Fed being trapped.
This is an uncomfortable backdrop for the Treasury and bond markets.
Loose conditions continue to fuel manic late-cycle asset inflation and debt issuance, underpinning already elevated inflation.
And a new administration will soon move to implement a laundry list of budget-busting tax and spending campaign promises.
Meanwhile, now interminable late-cycle bubble fragilities ensure the inevitability of desperate inflationary policy measures.
I don’t want to make too much of poor bond market performance following one Fed rate cut.
But enormous speculative leverage has accumulated in markets on the premise of an open-ended Federal Reserve liquidity backstop.
Moreover, there has been a recent parabolic spike in leverage in anticipation of an aggressive Fed easing cycle.
Risk of bond market instability and deleveraging is growing, while the manic stock market speculative bubble is an accident in the making.
And we’ve already witnessed bubble fragility reveal itself globally within the massive yen “carry trade” and AI/tech mania.
Next week’s election creates a possible catalyst for market reassessment and de-risking.
At the same time, with all the derivatives and hedging, there’s potential for a post-election head-fake rally.
Hopefully, election outcomes don’t drag on for days and even weeks – and that results are not contested.
Coupled with escalations at various geopolitical flashpoints, market risk today is at the highest level of my career – arguably the highest in generations.
I’ve fallen into the habit of concluding with a simple wish: I hope I’m wrong.
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