Issues 2025
Doug Nolan
Year 26.
I’ve been posting the CBB for so long I barely remember what a normal Friday evening feels like.
I face a dilemma this year.
Potentially one of the most powerful individuals in human history takes office in 10 days.
He is a most determined “disruptor” in a world deeply fractured, yet unified in one historic financial Bubble.
Following epic 2024 “terminal phase excess,” myriad global Bubbles inflated further to unparalleled extremes.
“To me the most beautiful word in the dictionary is tariff.”
All too happy to sow disorder, a fragile world risks being wrenched to the breaking point.
In my first CBB, I promised readers to “call them as I see them and let the chips fall where they will.”
It has become a challenge to live up to a pledge I’ve taken to heart for so many years.
I’m compelled to shoot straight on this.
I’ve voted Republican for much of my adult life, including for Bob Dole and John McCain.
I cast ballots for and against Donald Trump.
More importantly, I am fiercely independent in my analysis and politics.
Wary of ideologies.
Character matters tremendously.
Not by coincidence do I work for an individual (David McAlvany) with unassailable character.
No amount of money could lure me to work with schmucks.
Irrespective of talents as educators, I would have serious issues if my son’s high school teachers demonstrated obvious character issues.
It doesn’t feel right to expect so much less from our political leaders, but that’s where we’ve landed in this most extraordinary of environments and cycles.
I was ready to keep an open mind with Trump 2.0.
That ended swiftly, with the gut punch of Matt Gaetz hand selected as Attorney General nominee.
It was an affront to our deeply divided nation in dire need of mindfulness and mending.
I want so much to just stick with my analysis and avoid politics (like the plague).
But the CBB has a subtitle: “Chronicling History’s Greatest Financial Bubble.”
Especially at this cycle’s perilous turning point, politics and policymaking have become fundamental to market, financial, economic, and geopolitical analysis.
I would prefer not to upset readers.
I could take a year or four off.
But I passionately believe this period will be studied for generations – and I want my legacy to be rigorous, sound, and factual contemporaneous analysis of a critical period in U.S. and world history.
For better or worse, the Trump administration will force momentous change both at home and abroad.
From the perspective of my analytical framework, it’s not coincidental that our President returns to the White House with the world at the brink – with manias and acutely vulnerable speculative Bubbles; with a deeply maladjusted U.S. economy and associated inequality and acute societal strain; with political dysfunction and corruption; with escalating trade and military wars at risk of spiraling out of control; with an antagonistic world and precarious geopolitics.
For the foreseeable future, there may be a need for CBB warning labels: “Some readers may find the following content offensive and disturbing.”
I doubt President Trump’s agenda will prove even close to feasible.
A populist agenda for bettering the lives of many millions left behind over decades of boom-time economic transformation, while ensuring that stock and bond market Bubble inflation runs unabated. Stoking a boom while taming inflation.
The billionaire class clearly has the President’s ear, while their position in the world lives or dies with the Bubble.
Populism so long as the super wealthy continue to get more than their share.
The numbers don’t work in today’s world.
Reduce taxes; deregulate and cut red tape; stoke investment and growth; boost production and reduce energy prices, while betting the ranch the boom can be extended for four years.
It’s an agenda more suited for emerging out of a downturn than prolonging fateful excesses that will conclude a historic super cycle.
In previous “Issues” pieces, I would repeat a critical maxim: Bubbles inflate or burst.
Importantly, last year’s spectacular “terminal phase excess” creates quite a predicament.
Manic speculative excesses and leveraged speculation ensure market fragility, as well as systemic frailty that significantly elevates crash risk.
Last year’s only looser financial conditions fueled deeper economic structural maladjustment.
The CBO is projecting a $1.9 TN, or 6.5%, federal deficit this fiscal year.
I’ll take the over.
Friday’s much stronger-than-expected payroll data are further evidence of a U.S. “Bubble economy” at the cusp of overheating.
And 2025 begins with the University of Michigan one-year consumer inflation expectations jumping to the highest level (3.3%) since 2008, confirming that inflation risk remains to the upside.
This followed the ISM Services (December) Prices Paid component surging to a 22-month high (64.4).
I expect the bond market to be a major Issue 2025.
This week’s 16 bps rise in 10-year Treasury yields pushed the year-to-date (7 sessions) yield jump to 19 bps.
Importantly, 10-year yields are up 111 bps since the Fed commenced a 100 bps rate reduction in September.
Yields are now at the highest level since October 2023.
With 10-year yields approaching the 2023 high of 5%, it’s important to note a key difference between this year and the yield spike years 2023 and 2022: markets previously took comfort in the belief that the Fed could be counted on to halt hikes and begin rate slashing if surging market yields began to foment instability.
Now what.
The Fed aggressively cut rates, and market yields spiked (in their and the markets’ faces).
In notable contrast to recent years, Bubble “inflate or burst” comes with the caveat that 2024 ended with notable instability unfolding at the global Bubble’s “periphery”.
After last year’s currency and bond market losses, EM entered 2025 already impaired and vulnerable to crisis dynamics.
The year is off to a rocky start.
Local currency yield jumps include Romania 39 bps, Hungary 35 bps, South Africa 30 bps, Indonesia 20 bps, Cyprus 20 bps, Latvia 15 bps, and Poland 15 bps.
Dollar-denominated “developing” debt remains under significant pressure.
Year-to-date yield jumps include Colombia 40 bps, Ukraine 39 bps, Chile 22 bps, Saudi Arabia 20 bps, Peru 19 bps, Philippines 18 bps, Turkey 16 bps, Indonesia 13 bps, Panama 12 bps, and Mexico 11 bps.
After a notably rough Q4, Brazil’s currency and bond market have nervously held their own to start the year.
Chinese markets are not holding their own.
China’s Shanghai Composite has dropped 5.5% in seven sessions, with the growth oriented ChiNext index hit 7.8%.
Chinese stocks have given back about half of the 35% Beijing-induced rally that followed September announcements of a laundry list of aggressive stimulus measures.
Much improved Chinese sentiment lent some needed support to the increasingly vulnerable emerging markets.
January 10 – Bloomberg:
“An escalation of China’s fight against bearish traders has failed to allay fears that the world’s second-largest economy is headed for a deflationary spiral.
The renewed effort by authorities to prop up financial markets this week has drawn a muted response.
The yuan is hovering near the weaker end of its trading band and the benchmark bond yield is just a few bps away from a record low.
The MSCI China Index is poised to enter a bear market.
That’s even after the People’s Bank of China undertook successive steps to engineer a reversal.”
It's understandable that Beijing would focus on orchestrating a potent lift in stock market enthusiasm as a key catalyst to spark a much-need economy-wide boost in consumer and business confidence (having repeatedly worked its magic in the U.S. and elsewhere!).
But it’s an odd dynamic to have such an overhanded central government working urgently to manipulate financial market confidence.
China is a major Issue 2025.
Beijing is trying to sustain unsustainable Bubble-period financial and economic structures – increasingly desperate to hold Bubble deflation at bay.
China’s predicament is compared to the bursting of Japan’s 1980s Bubble.
There are some parallels, but China’s Bubble dwarfs Japan’s in scope and global impact.
Moreover, Tokyo came to recognize the damage that excesses were inflicting on Japan’s society and institutions, making the difficult but necessary decision to deflate its Bubble.
There is today, both domestically and internationally, too much at stake for China’s communist leadership and party for Beijing to even contemplate the consequences of Bubble deflation.
Japan’s bursting Bubble barely registered geopolitically.
China’s will trigger an earthquake.
If December estimates prove accurate, growth in China’s Aggregate Financing (metric of system Credit growth) expanded an enormous $4.35 TN last year.
Huge ongoing expansion, still down from 2023’s $4.90 TN – with moderations in Credit growth the proverbial kiss of death for Bubbles.
Beijing has been moving up the learning curve.
They have hesitated to provide the massive stimulus market analysts have been demanding – the enormous scope of new debt that would be required to temporarily contain Bubble deflation.
January 10 – Bloomberg:
“China’s central bank said it will suspend buying government bonds, its latest attempt to temper investor bets on weak economic growth that have undermined the currency and sapped confidence among businesses and consumers.
The People’s Bank of China will halt purchases of sovereign debt this month…
The central bank will pick a time to resume buying depending on market conditions…”
The renminbi is an Issue 2025.
The unrelenting expansion of non-productive debt in China places its currency in harm’s way.
Central bank liquidity; to inflate the stock market; to boost apartment buyer and consumer confidence; to support vulnerable local governments; to sustain a tottering Bubble Economy – all place the renminbi in serious harm’s way.
The PBOC (and state-directed banks) currently have the currency pegged at the 7.30 level.
Beijing would surely prefer a carefully managed devaluation, especially as it prepares for additional tariffs.
Losing control is anathema.
China’s major banks have become big players in currency and derivatives trading.
To what extent have derivatives been used in currency support operations to preserve its international reserve holdings?
And the longer Beijing clings to the currency peg – the larger the buildup of bank and speculative derivative positions – and the greater the potential for a destabilizing currency market dislocation.
Over the years, I’ve pondered the question: Is China “developed” – or does it remain more a “developing” system vulnerable to crisis of confidence dynamics.
EM central banks and governments traditionally lose the capacity to stimulate when focus turns to stabilizing a disorderly run on their currencies.
It seems a pertinent issue to begin the new year.
With EM currencies and bonds under pressure, heightened Chinese instability would only accelerate crisis dynamics.
Beijing pressed its bet on an already bloated export sector, determined to offset the deleterious effects of its bursting apartment Bubble – while meeting growth mandates.
Now facing additional backlash from the U.S. and Europe, faltering demand from its “global south” trade partners would be a serious blow.
Over the years, I’ve referred to China as the “king of EM.”
There is today elevated risk that unfolding EM/China instability and crisis dynamics feed on each other, testing years of integration.
I expect the “Periphery and Core” analytical framework to be especially valuable in 2025.
“Periphery” instability has recently made the leap to the “core.”
EM central bank selling international reserve holdings (chiefly Treasuries) to accommodate de-risking/deleveraging and resulting “hot money” outflows is contributing to the surprising jump in U.S. and global market yields (in the face of central bank rate cuts).
It’s worth noting that Fed holdings for foreign (chiefly central bank) owners of Treasury and Agency Debt dropped $49.4 billion in two weeks (to the low since May 2017), the largest drop back to (banking crisis) March 2023.
Meanwhile, weakness gained noteworthy momentum this week at the periphery of the global “core.”
January 8 – Bloomberg (Greg Ritchie and James Hirai):
“UK markets tumbled, pushing bond yields to the highest in more than a decade, as jitters over persistent inflationary pressures sparked unnerving comparisons with the 2022 gilt crisis.
Benchmark 10-year yields jumped as much as 14 basis points to 4.82%, the highest since August 2008.
The pound fell against all major currencies, slumping more than 1% versus the dollar, while UK stocks fell.”
Ominously, UK government “gilt” yields surge 25 bps this week to 4.84% - the high since July 29th, 2008.
The pound sank 1.7% to a 14-month low.
Recall the UK bond market was at the de-risking/deleveraging epicenter when the bond vigilantes put a quick end to Prime Minister Liz Truss and her government’s spend-thrift budget.
That crisis was a reminder of the role leverage and derivatives play in contemporary bond markets.
It was also an early warning of shifting global bond market dynamics, something governments globally would have been well-served heeding.
Risks are mounting that Trump administration budget plans could provoke a similar bond market revolt.
De-risking/deleveraging equates to waning demand and liquidity throughout global markets.
“Contagion” ensures heightened risk aversion.
What markets are susceptible to reassessment of risk versus reward calculations?
And when “risk off” turns more serious, what markets are vulnerable to destabilizing speculative deleveraging?
In no way is the “core” immune.
“Basis trades” and “carry trades” are an Issue 2025.
So far, confidence remains rock solid that the Fed will ensure a liquid and stable Treasury market.
But the recent surprising yield spike must be at least somewhat unnerving.
And an overheated economy with resurgent inflation would have the Fed thinking twice before coming aggressively to the markets’ defense.
What’s more, Team Trump comes with layers of uncertainty.
The bottom line: risks – marketplace instability and liquidity, Washington spending and budgets, the timing and scope of the Fed’s market liquidity backstop, the fraught geopolitical backdrop – are mounting to the point where they will be an increasing concern for the egregiously levered “basis trade” and speculative leverage more generally.
The historic AI/tech mania/Bubble is an Issue 2025.
There are troubling parallels between the two “Roaring Twenties.”
The original was notable for the unappreciated role speculative leverage (and resulting liquidity abundance) played in fueling epic technological advancement coupled with unrecognized deep structural maladjustment.
The 1929 crash and crushing deleveraging unmasked the scope of financial excess, resource misallocation, spending distortions, and uneconomic Bubble-period investment.
AI is a spending black hole with potential to be one of history’s greatest technological advancements and investment theses.
But it requires loose conditions, ample liquidity, risk embracing lenders and financiers, and massive outlays – all that must be sustained in the face of quite uncertain market, economic and geopolitical backdrops.
Will there be enough “money” to go around?
And will AI remain the top priority as things turn dicey?
January 10 – Bloomberg (Manya Saini):
“U.S. insurance stocks slid on Friday as analysts estimated insured losses from the wildfires menacing Los Angeles could reach as high as $20 billion, potentially making it the costliest disaster in California's history…
The fires, engulfing iconic Los Angeles neighborhoods and tearing through the Hollywood Hills, have so far killed 10 people and destroyed nearly 10,000 structures.
Private forecaster AccuWeather estimated the damage and economic loss at $135 billion to $150 billion, portending an arduous recovery and a surge in homeowners' insurance costs.”
Only a few months after the devastating winds and historic flooding from hurricanes Helene and Milton, mother nature unleashes catastrophic wildfires that incinerate thousands of homes and businesses, along with entire communities.
There will be investigations, reports and ample finger-pointing.
Budget cuts, lack of equipment and manpower, old and deficient water infrastructure, defective energy infrastructure, lack of effective preparation, homeowner complacency, and so on.
Climate change has reached a critical juncture, and we should assume it only worsens from here.
Preparation has not been a priority.
Denial will be increasingly costly in life and property – increasingly untenable for societies at home and abroad.
At least in the short term, pessimism comes easy for the issue of limiting carbon emissions.
“Drill, baby, drill” has a political mandate.
And don’t expect a world facing heightened financial and economic instability to be in the mood to sacrifice much for the good of the planet.
The old Fram oil filter commercial: “Pay me now or pay me later.”
Necessary climate-related spending is an Issue 2025.
If last year’s alarming hurricanes, flooding, and wildfires were not a sufficient wake-up call, the first week of the year provides horrific evidence of today’s climate reality.
As a nation, we are woefully unprepared.
One way or another, governments – local, state, and federal – will face enormous costs for upgrading systems and infrastructure necessary to protect residents and citizens.
Households across the country will confront the harsh reality of higher insurance (and other) prices and expenses necessary for even minimal preparation.
Large areas of the country today face highly elevated risk of catastrophic losses.
Since last April, the Los Angeles area has received 0.15 inches of rain.
Much of Southern California now faces year-round dry and potent “Santa Ana” winds and potentially devastating wildfires.
The entire West Coast faces newfound wildfire risks.
With an increasingly balmy Gulf of Mexico, states all the way to North Carolina and beyond face unprecedented storm-related risks.
The polar vortex to begin 2025 is a reminder of energy infrastructure fragility.
Even without AI, our nation’s power grid is not up for today’s climate change and geopolitical realities.
With AI, it’s a colossal infrastructure spending and financing challenge.
A world of unhinged AI and crypto mining seems more a Bubble phenomenon than practical reality.
January 10 – New York Times (Andrew Ross Sorkin, Ravi Mattu, Bernhard Warner, Sarah Kessler, Michael J. de la Merced, Lauren Hirsch and Benjamin Weiser):
“The ferocious wildfires that have burned throughout the Los Angeles area continued to rage overnight, consuming an area twice the size of Manhattan. Forecasters expected ‘critical red flag’ conditions to continue on Friday before the hurricane-force winds that have fueled the blazes subside in the afternoon.
The devastation has more people asking one hard question: Has this part of California become uninsurable?”
Is Southern California insurable?
It raises a critical issue.
Insurance works when loss claims are random and independent.
Actuaries have historical data that provides the basis for pricing individual auto and homeowner policies, ensuring reserves for future losses, along with some residual profit.
Years of data provide a good basis for predicting the number and expense of car accidents and house fires – or at least it used to work that way.
Individual home fires in some areas are no longer random – they come in waves and tend to come in appealing (aka expensive) locations, such as Pacific Palisades and Malibu.
January 10 – Reuters (Andy Sullivan):
“The Pacific Palisades area ravaged by wildfires in Los Angeles is one of the most expensive neighborhoods in the U.S., home to Hollywood A-Listers and multimillion dollar mansions.
And ahead of this week's disaster, its insurance costs were among the most affordable in the country, according to a Reuters analysis…
That may be about to change.
The scale of losses anticipated in the wildfires now ringing Los Angeles, as well as regulatory changes enacted late last year, could spell an end to relatively cheap homeowners' insurance in areas like the Palisades that are at elevated risk for wildfires…”
Recent momentous changes in wildfire risk had the traditional insurance companies running for cover – just as the insurers ran for their lives from hurricane and flood risks around the Gulf.
On the East Coast, climate-change losses literally come in “waves.”
Random and independent are things of the past.
Some critical insurance markets no longer work, so states such as California (fire) and Florida (wind and flood) have stepped in to provide affordable insurance.
The state of California’s “FAIR” insurance plan now faces massive losses and a flimsy financial structure.
And when states realize the unacceptable cost to taxpayers from writing high-risk insurance in a high-risk climate environment, it’s unclear today where homeowners in risky locations will turn.
I’ll assume the federal government will be on the hook for massive climate-related costs – losses, remediation, preparation, and infrastructure spending.
I don’t see how climate change doesn’t become a factor in bloated budgets and inflationary pressures – likely an Issue 2025.
With myriad risks percolating, will the bond market give a thumbs up or down to this year’s Washington budget process?
Could the “crowding out” concept make a comeback after a few decades of dormancy?
Returning to failing insurance markets in California and nationally, I’m reminded of “A Derivatives Story.”
In a March 2000 CBB, I shared the tale of a quiescent little town on a pristine river that succumbed to a speculative Bubble in selling flood insurance.
Importantly, the newfound availability of affordable flood protection spurred risk-taking and a spectacular building boom along the water.
Sadly, the inevitable arrival of flood waters triggered an insurance marketplace panic and collapse, along with catastrophic losses for scores of riverfront homeowners, the “insurers,” and the community at large.
For the past couple decades, the Fed, global central bank community, and governments worldwide have repeatedly bailed out faltering risk markets, ensuring ever more distorted market risk perceptions and a historic global Bubble.
Similar to today’s California fire losses, market risks are uninsurable – neither random nor independent.
Market losses come in “waves”, and the mispricing of market risk has for years promoted increasingly aggressive risk-taking – “careless building within the flood plain”.
Derivatives markets are poised to be an Issue 2025.
I expect market liquidity issues to be an Issue 2025, along with de-risking/deleveraging.
Deflating Bubbles will change so many things.
Tighter financial conditions will be problematic for scores of profitless businesses and uneconomic ventures.
An abrupt tightening would be particularly destabilizing for the historic “subprime” lending boom, including “private Credit,” leveraged lending, “decentralized finance,” venture capital, and private equity.
Entire industries have blossomed on the notion that markets will indefinitely accommodate whatever financing needs are required.
The AI Bubble – especially the buildout of data centers and energy infrastructure - is uniquely vulnerable to tighter Credit.
Faltering Bubbles will reveal the fiscal train-wreck festering in California and elsewhere.
To wrap this up, today’s extraordinary geopolitical environment will unfortunately receive short shrift.
Leave no doubt, geopolitical risks are an Issue 2025.
The Trump tariffs will get things going.
Hopefully, there will be positive developments in Ukraine.
Meanwhile, I expect China to continue to tighten the noose around Taiwan’s neck.
Will China test the new Trump administration, and perhaps link Taiwan’s status and U.S. military support to trade negotiations?
It’s hard to believe Iran and its nuclear program won’t be an Issue 2025.
Let's hope the relative lull in Middle East conflict is more than just a short-term development.
Mainly, when it comes to geopolitical risks, expect the unexpected from such an erratic and volatile world.
It’s reasonable to expect that faltering Bubbles will exacerbate instability and global conflict.
The U.S. Bubble economy is a wildcard Issue 2025.
A formidable head of steam seems to ensure the type of momentum that will keep the bond market irritable.
Ditto for inflation.
Isn't the bond market, after all, signaling a new paradigm of waning tolerance for fiscal profligacy?
And all bets are off when market Bubbles falter.
Acute financial fragility is an Issue 2025.
Beyond derivatives and levered finance, the ETF universe, replete with epic risk misperceptions (“moneyness of risk assets”), remains an accident waiting to happen.
I worry about the ballooning money market fund complex.
The entire tech Bubble is so vulnerable to an unexpected tightening of financial conditions.
How the Trump administration reacts to financial instability is an Issue 2025.
Don’t expect supportive words for Powell and the Fed.
There will be intense pressure on the Fed to cut rates and restart QE.
It will be fascinating to watch how all this plays with today’s reconditioned bond market.
And it’s interesting to see a hedge fund “master of the universe” back at the helm at Treasury.
This undoubtedly provides some comfort for the levered speculators and “basis trade” players.
Ten days away from day one.
From a purely analytical perspective, 2025 appears destined for uniqueness, greatness and perhaps infamy.
I’m excited for the intensity that comes with extremely challenging analysis.
Interesting to see the precious metals and commodities handily outperform financial assets this week.
May we live in interesting times.
0 comments:
Publicar un comentario