Normal Deleveraging and Trade Wars
Doug Nolan
Deleveraging gained powerful momentum early in the week, with global debt markets at the cusp of “seizing up.”
90-day Tariff Pause.
April 9 – Bloomberg (Hadriana Lowenkron and Daniel Flatley):
“Treasury Secretary Scott Bessent played down a selloff in US Treasuries, saying that there was nothing systemic at play, and also served warning against China not to attempt to devalue its exchange rate in retaliation for American tariff hikes.
‘There’s one of these deleveraging convulsions that’s going on right now in the markets,’ Bessent said on Fox Business, adding that he’d witnessed those very often in his decades-long hedge-fund career.
‘It’s in the fixed-income market.
There are some very large leverage players who are experiencing losses — that are having to deleverage’…
‘I believe that there is nothing systemic about this — I think that it is an uncomfortable but normal deleveraging that’s going on in the bond market,’ Bessent said.”
“Bond Market Turbulence Lifts 30-Year Yield Most Since March 2020.”
“US government debt sells off as hedge funds cut down on risk.”
“Is China dumping U.S. Treasuries?”
“Bond Analysts Debate If China Had Role in Treasuries Swings.”
“Bond Markets Retreat as US Treasuries Lead Yield Jump Worldwide.”
“No Emerging Market Is Spared From Trade War Losses on Dollar Debt.”
“Asian Stocks Tumble Most Since 2008 on Global Recession Worries.”
There was nothing “normal” about this week’s deleveraging - nothing if not systemic.
At week’s end, an optimist might think this was just another bout of instability soon to be forgotten.
There was the October 2022 Liz Truss deleveraging fiasco.
March 2023 saw the bank run eruption and mini crisis.
The more germane deleveraging erupted with the unwind of yen “carry trade” leverage back on August 5th, 2024.
The August deleveraging was thwarted by Bank of Japan comments on August 6th, soon followed by a dovish pivot by Powell at Jackson Hole.
As markets recovered, the narrative immediately shifted to, with yen “carry trade” leverage unwound with minimal impact, the coast was clear to get back to leveraging and speculating.
I was skeptical of the whole unwind narrative.
There was likely a significant unwind of currency and swaps positioning.
But there was no way the massive leverage in higher yielding debt instruments (funded with cheap yen borrowings) could have been unwound over a few days or even weeks.
Such deleveraging would have been systemic and deeply impactful to global market liquidity.
I actually believe that unwind is ongoing.
It’s worth noting that local currency Brazilian 10-year yields increased 350 bps between August and year-end, to 15%.
Yields were up 100 bps in Mexico, 200 bps in Colombia, and 300 bps in Turkey.
A Friday WSJ (Jon Sindreu) article captured today’s deleveraging fears: “The basis trade, said UBS strategist Michael Cloherty, has ‘become the scary monster under the bed that gets blamed for everything.'”
There are all varieties of leveraged speculation in myriad instruments across fixed income in the U.S. and globally.
Leveraged speculation has proliferated for decades, and it’s reasonable to think in terms of tens of Trillions of leverage globally.
There was stress almost across the board this week, including “carry trades” and “basis trades” and especially the “swaps” derivatives marketplace.
Barring global markets seizing up, deleveraging will be an ongoing challenge over the coming weeks and months.
This week was merely a notably rocky start to the process, and I doubt much progress has been made in unwinding the massive “basis trade” in Treasuries.
There are a few dominant “basis trade” operators that won’t be able to come out of their positions without Federal Reserve assistance.
From Bloomberg Intelligence’s Brian Meehan:
“There’s a Basis-Trade Blowup, Just Not the One People Expect.”
“Fears of a massive unwinding of long positions in the cash Treasury/Treasury futures basis trade appear overblown as the relative performance of cash vs. futures doesn’t indicate large liquidations.
Also, open interest in Treasury futures hasn’t signaled steep declines witnessed in previous blowups.”
Ten-year Treasury yields spiked 50 bps this week, the largest weekly jump since the week of August 16, 2001 – a bond shellacking Bloomberg at the time called “the biggest weekly loss in at least 24 years.”
That was also the week of an Alan Greenspan quote of historic note: “If I answered that in a way which you think you understand what I said, I made a mistake.
Remember, the purpose of monetary policy is to address the structure of financial markets - that’s what we do.”
I appreciate that Chair Powell never succumbs to such blather.
But everyone sure loved it when the “Maestro” was at the top of his game.
I do digress, but the structure of financial markets, having evolved so momentously starting with the Greenspan era, has never been as fragile.
When the Treasury market is the foundation and Treasuries are crumbling, U.S. and global market structures have serious structural fragility.
Benchmark MBS yields surged 56 bps this week to 5.91%, the largest jump since the week of March 13, 2020 (Fed ratcheting up pandemic crisis lending facilities).
From Tuesday’s low to Friday’s high, MBS yields spiked 65 bps.
April 11 – Bloomberg:
“The Fannie Mae 30-year current-coupon spread to the 5/10-year blend widened 6 bps to +160 as the U.S. Treasury 10-year yield rose 11 bps to 4.29% and volatility rose.
The spread was the highest in more than 13 months.
Volatility was the highest in about 18 months.”
“Mortgage rates slingshot higher as tariff uncertainty roils markets.”
“Brutal Week Sees Junk Debt Refinancing Costs Double in 2025.”
“Cracks Are Forming in CLO Market as ETFs on Record Selling Spree.”
“Investors lose $25bn in leveraged ETFs in sector’s biggest meltdown.”
“‘The World Is Different Now’: Market Convulsions Hit Wall Street.”
June bond yields were up 96 bps in seven sessions to 8.58%, trading this week to the high since October 2023.
Leveraged loan prices traded to lows since July 2023.
“Private Credit” has serious unfolding issues, with ramifications for “subprime” lending throughout.
April 11 – Bloomberg (Rachel Graf):
“As the US leveraged-loan market had no pricings or launches this week amid the ongoing tariff turmoil, the sector was among those from which investors fled to seek safer ground.
US leveraged loan funds had a record $6.5 billion pulled from them in the week through April 9.”
Muni (AAA) yields were up 89 bps at Wednesday’s close, before ending the week 66 bps higher at 3.39%.
April 8 – Bloomberg (Aashna Shah and Shruti Date Singh):
“A wave of tariff-induced selling pressure hit the municipal bond market on Monday, leading to the worst-performing day in more than three decades.
A benchmark index of municipal bonds dropped 2.85% on Monday, the biggest daily decline since at least 1994…
The historic rout caused several deals to be postponed and wiped out total gains for this year…
‘Monday’s session signaled a major risk-off move in the market,’ Kimberly Olsan, senior fixed-income portfolio manager for NewSquare Capital LLC, wrote…”
April 9 – Bloomberg (Amanda Albright):
“Municipal-bond yields surged another 20 bps Wednesday morning as the state and local debt market sees a continued steep selloff.
The rout drove the 10-year AAA benchmark to 3.7%, the highest since at least 2011…
Patrick Haskell, head of municipal bonds at BlackRock… said the US state and local debt market hit ‘panic levels’ Monday and Tuesday. Investors were ‘searching for liquidity,’ he said.”
When America sneezes, the world catches a cold.
What’s the prognosis when the U.S. has a malignant tumor?
Already fragile, EM bonds suffered a further spike in yields.
Dollar-denominated EM bonds were under notable selling pressure – indicative of intense deleveraging.
Ten-year yields surged 57 bps in Colombia, 49 bps in Turkey, 48 bps in Philippines and Mexico, 46 bps in Indonesia, 38 bps in Chile and 24 bps in Brazil.
With the yen gaining 2.4% this week (vs. $), there was intense pressure on levered yen “carry trades” – likely including dollar-denominated EM bonds.
Local currency EM bonds suffered the dreaded double-whammy – hefty bond and currency losses.
Versus the yen, the Indonesian rupiah fell 3.7%, the Peruvian sol 3.6%, Indian rupee 3.2%, Brazilian real 2.7%, Philippine peso 2.6%, South African rand 2.5%, Chinese renminbi 2.5%, Argentine peso 2.4%, and Turkish lira 2.1%.
Monday’s market bloodbath was notable.
“Emerging Stocks Sink Most Since 2008 as Tariff Turmoil Deepens.”
“Stocks in Hong Kong plunged 13.2% for their worst day since 1997” (AP).
“MSCI’s main emerging equity index slid 7.9%, its biggest drop since the 2008 global financial crisis” (Bloomberg).
Major index losses included Taiwan’s Taiex 9.7%, Japan’s Nikkei 7.8%, South Korea’s Kospi 5.6%, China’s CSI 300 7.0%, Philippines PSEi 4.3%, Australia’s S&P/ASX 200 4.2%, Malaysia’s KLCI 4.2%, and India’s Nifty 50 4.0%.
Germany’s DAX recovered from a 10% plunge to end Monday’s session 4.2% lower.
Also recovering from steep losses, France’s CAC40 closed the day down 2.3%.
The dollar Index sank 2.8%, trading Friday to a two-year low.
Levered “carry trades” in U.S. debt instruments financed in low yielding currencies (i.e., yen, Swiss franc, euro) had a rotten week.
Algorithmic models would have had essentially zero probability of 10-year Treasury yields spiking 50 bps - as the dollar sank almost 3%.
It’s simply hard to believe how messed up things were early in the week.
Stocks enjoyed a historic one-day rally and big up week.
Can we now just put “Liberation Day” on the south lawn behind us?
The tariff placard, the calculations, the propaganda?
Can we erase from memory global markets in meltdown mode?
Left for dead, the “Trump put” made a dramatic comeback.
When markets again approach the precipice, everyone – or at least the hedge funds - will wait anxiously for THE SIGNAL: “THIS IS A GREAT TIME TO BUY!!! DJT”
April 7 – Financial Times (Costas Mourselas and Antoine Gara):
“Shares in billionaire Bill Ackman’s main investment vehicle have fallen 15% this year as Donald Trump’s trade war hits the portfolio of one of his most ardent Wall Street backers.
The drop in Pershing Square Holdings… comes as the financier has turned sour on some of the US president’s policies in a major public reversal.
The trust’s share price fell more than 3% on Monday.
‘If… on April ninth we launch economic nuclear war on every country in the world, business investment will grind to a halt, consumers will close their wallets and pocket books, and we will severely damage our reputation with the rest of the world that will take years and potentially decades to rehabilitate,’ he said on X on Sunday.”
What a difference two days can make…
April 9 – The Hill (Tara Suter):
“Billionaire hedge fund investor Bill Ackman on Wednesday praised President Trump’s decision to implement a 90-day pause on reciprocal tariffs against foreign trading partners, with the exception of China.
‘This was brilliantly executed by @realDonaldTrump,’ Ackman wrote on the social platform X. ‘Textbook, Art of the Deal.’”
The hedge fund community had quickly landed in dire straits.
Ackman’s “Art of the Deal” compliment was like an individual who just landed an incredible deal praising the other side’s savvy negotiating tactics.
The great negotiator was forced to show his hand – to expose his point of vulnerability.
China, witnessing the weakness of its adversary, was quietly triumphal.
With steely resolve: “Got him just where we want him.”
April 10 – Wall Street Journal (Bertrand Benoit and Kim Mackrael):
“Relief spread around the world on Thursday after President Trump suspended enforcement of some of his global tariffs, but the U-turn raised the question of whether big concessions on trade need to be made to mollify an American leader who had been humbled by the market…
‘Everyone will likely conclude that [Trump’s] credibility as a negotiator has diminished,’ said Moritz Schularick, head of the Kiel Institute for the World Economy, a think tank.
‘Next time, people will believe him even less and will consider at what point he might buckle again.
It certainly hasn’t become easier for the U.S. to negotiate.’”
April 8 – CNBC (Jeff Cox):
“Treasury Secretary Scott Bessent said Tuesday the U.S. holds a substantial advantage over China as the two nations exchange threats in a burgeoning trade war.
‘I think it was a big mistake, this Chinese escalation, because they’re playing with a pair of twos,’ Bessent said…
‘What do we lose by the Chinese raising tariffs on us?
We export one-fifth to them of what they export to us, so that is a losing hand for them.’”
If Xi Jinping is playing with a “pair of twos,” what hand might President think he’s playing with?
April 8 – Reuters (Laurie Chen, Kevin Yao and David Kirton):
“Beijing, feeling boxed into a corner by the United States’ intensifying tariff assault on China and any country that buys or assembles Chinese goods, is bracing for an economic war of attrition….
‘Whoever surrenders first becomes the victim,’ said a Chinese policy adviser…
‘It’s a matter of who can hold out longer.’”
“Markets Plummet as Tariff-War Woes Fuel Exodus From US Assets.”
“US Treasuries sell-off deepens as ‘safe haven’ status challenged.”
“Treasuries Selloff Ramps Up as Investors Spurn US Long-End Bonds.”
“Monday’s Jump in 30-Year Treasury Yields Suggests Doubts Over Safety of U.S. Assets.”
“U.S. Bond Sell-Off Is Another Worrisome Echo of the Liz Truss Fiasco.”
I can’t imagine an objective of greater priority for Xi Jinping and China’s communist party than to see the downfall of so-called U.S. “exorbitant privilege.”
This incredible competitive advantage has provided incredible benefits to its global superpower rival for decades - compliments of the world’s safe haven Treasury market (and financial markets more generally) coupled with the globe’s dependable reserve currency.
Now, Donald Trump has unwittingly exposed U.S. Bubble fragilities, vulnerability combined with reckless policymaking, which places U.S. markets, the American economy, and the dollar at great peril.
China has company in wanting to see Trump’s America taken down several notches: Russia, North Korea, Iran and, unfortunately, much of the “Global South.”
Even (former) allies likely today recognize the leverage that would be gained from the U.S. suffering some comeuppance.
April 11 – Bloomberg (Masaki Kondo):
“The decline of the US’s credibility as a safe haven for financial assets is going to cause issues in the market long-term, according to Westpac…
Wednesday’s ‘price action for fixed income markets, specifically Treasuries, has no historical precedent,’ Martin Whetton, head of financial market strategy at Westpac, wrote…
‘It is not so much the range — wide and choppy, but the nature of the violent unwind and fall in liquidity, or actually the absence of the liquidity that is concerning.’
‘The age of US exceptionalism — at least financially — has come to an end.’
Creditors’ willingness to finance US deficits has decreased.
It’s ‘startling and a sharp warning’ that money didn’t scramble to secure dollar funding via the basis markets to buy Treasuries and the dollar for safety.”
I’ve viewed “US exceptionalism” as a key element of peak Bubble delusion.
A bulletproof Treasury market and resilient dollar have afforded incredible U.S. advantages.
We’ve operated virtually without constraint – debt growth, fiscal deficits, consumption, current account deficits, asset inflation and Bubbles, deindustrialization, a services-based economy, and unlimited liquidity to pursue whatever technology advancement or financial whim to galvanize highly speculative financial markets.
And when Bubbles inevitably falter, the Fed has enjoyed open-ended capacity to reflate – from Bernanke’s Trillion to Powell’s $5 TN – a backstop instrumental in U.S. market exceptionalism.
Truth be told, “US exceptionalism” was financed by endless liquidity, much of it originating from leveraged speculation backstopped by the Federal Reserve.
It inflated into history’s greatest Bubble, with going things completely off the rails post-Covid.
I hear and read some seasoned market players confidently asserting that the U.S. has a dominant position vis-à-vis China.
The U.S. economy and financial system are “hands down” stronger and more resilient.
But this view ignores U.S. Bubble fragilities – financial, economic, and social.
April 8 – Bloomberg:
“China pledged to retaliate against Donald Trump’s latest tariff threat and mobilized state organs to send a message of resilience, raising the risk of a prolonged trade war between the world’s two largest economies.
‘The US threat to escalate tariffs on China is a mistake on top of a mistake,’ the Chinese Ministry of Commerce said…
‘If the US insists on its own way, China will fight to the end.’”
The U.S. and China both have a tremendous amount to lose.
We can only pray cooler heads prevail.
But Beijing today has a lot to gain.
A unique opportunity has landed in Xi Jinping’s lap.
A global financial crisis would present challenges, but it would clearly be blamed directly on Donald Trump.
The Chinese population would rally around Xi and the communist party, blame deflected from their own formidable policy blunders and mismanagement.
A Trump global crisis would also afford China the opportunity to expand its circle and global influence.
One rival superpower stacking up friends and allies – with the other floundering and humbled.
Beijing might also calculate that a U.S. in disarray would be less compelled to exert influence in Asia - and less likely to come to Taiwan’s defense.
A world with an impaired U.S. would be a playground for China and Russia.
A world without U.S. “exorbitant privilege” would be a dream come true.
Just imagine the elation when Xi and Putin huddle together.
If U.S./China trade war analysis lacks sufficient challenge, give current market analysis a whirl.
April option expiration is next Friday, so I’ll take a cowardly approach and state conclusively that “anything could happen.”
Bonds, fixed income, and currencies will remain the big story.
The world is in the initial phase of a wrenching deleveraging that I expect to last months and likely years.
We can think in terms of the first round having quickly escalated to the brink of markets “seizing up," only to be pulled away from the precipice by 90-Day Tariff Pause.
Somewhat of a recovery is possible, fueled by short squeezes and the unwind of hedges.
But markets have been severely impaired.
No putting the toothpaste back in the tube.
Confidence has been badly shaken. The extreme degree of uncertainty (i.e., Trump, US/China trade war, economic and inflation risks) ensures an environment inhospitable to leverage.
The leveraged speculating community has been fractured.
The game works well when everyone has conviction to stay in the game.
The game turns problematic when interests diverge – each billionaire for himself – dog eat dog.
With deleveraging having gained powerful momentum, liquidity will be an ongoing issue.
Like the August yen “carry trade” unwind, there’s been a mad rush to put on hedges and bring down leverage.
But actual deleveraging of portfolios and strategies will take time - and ensure clouds hang over markets.
Furthermore, in the markets the past couple weeks there has been a distinct look of algorithmic models being blown to smithereens.
An eruption of global deleveraging – and yet Treasury yields spike 50 bps, and the dollar sinks 2.8%.
The virtually impossible is suddenly commonplace, a nightmare dynamic for the crowded population of over-confident quant traders.
Moreover, the newfound high risk Treasury dynamic must be causing tons of grief in lots of levered strategies that hold Treasuries to hedge portfolios of risk assets.
Spiking Treasury yields is a major market, financial and economic issue – at home and abroad.
Does Beijing do a cold calculation - and go for the jugular?
“Fight to the end” doesn’t sound like a bluff.
April 10 – Bloomberg (Ruth Carson and Masaki Kondo):
“After a week of wild swings in the US bond market, China’s holdings of Treasuries are increasingly under scrutiny from analysts around the world.
Some have gone as far as suggesting — without hard evidence — that sales by Beijing may have helped fuel the biggest surge in 30-year yields since the pandemic and subsequent volatility.
Others debate whether China might turn to dumping US debt in the future as a response to the steepest American tariffs in a century.
‘China may be selling Treasuries in retaliation,’ wrote Ataru Okumura, a senior interest-rate strategist at SMBC Nikko Securities in Tokyo…
Should this be the case, China has an incentive to show ‘it won’t hesitate to cause turmoil in the global financial market in order to improve its negotiating power against the US.’”
April 10 – Bloomberg (Lionel Laurent):
“The bond market spoke; Donald Trump blinked.
The lettuce theory of Liz Truss holds true: No leader, not even one who has shrugged off assassination attempts and a fraud trial, can remain steadfast in the face of a policy-induced meltdown that punishes voters it aims to protect.
The question is: What now?
What’s clear from markets is that the 90-day reprieve from worst-case tariffs on ‘any country, except for China’ is by no means a back-to-square-one moment.
The dollar’s haven status has been hurt…
The US remains a place where policy uncertainty is high, where tariffs can jump by double digits in days and where social-media influencers wield power over generals.
This uncertainty is what deters investment and hurts economic confidence, rather than just tariffs.”
April 11 – Bloomberg (Catarina Saraiva):
“Federal Reserve Bank of Minneapolis President Neel Kashkari said he’s not seeing stresses in the Treasury market that would merit an intervention by the US central bank.
‘I’m not seeing big dislocations yet, I’m seeing some stresses but markets seem to be adjusting OK so far,’ Kashkari said Friday…
Kashkari said the Fed had the tools to respond if needed, but only in severe circumstances.
‘The Fed or Treasury stepping in should be done reluctantly, should be done when it’s only truly needed,’ he said.”
President Trump’s 90-Day Tariff Pause capitulation must have been quite the topic of conversation in the Marriner S. Eccles Building.
I’m sticking with the assumption that the Fed will be late in responding to deleveraging and marketplace illiquidity.
They now have the added incentive to wait out market stress in anticipation of additional Trump capitulation.
The ambiguous Fed liquidity backstop is one more major reason why the leveraged speculating community must rein in risk.
April 8 – Bloomberg (Annie Massa and Katherine Burton):
“‘My bad.’
It was nearly 9 p.m. and Bill Ackman, public face of the billionaire class that embraced Donald Trump, was tweeting his way into the eye of the financial storm.
World markets were reeling because Trump, to the smart money’s apparent surprise, was following through on his oft-repeated threats to impose punishing tariffs.
Only months ago, Ackman celebrated Trump’s victory, predicting ‘the most pro-growth, pro-business, pro-American’ administration he’d seen in his adult life.
Now, on a Sunday night — after nearly $6 trillion had been wiped out in an epic two-day market rout, with more pain to come — Ackman was launching into mea culpa mode.
‘I don’t think this was foreseeable,’ the hedge-fund mogul posted on X.
‘I assumed economic rationality would be paramount.’
Ackman, like so many on Wall Street, assumed wrong.”
Confidence has been badly shaken.
Trust in the administration is irreparably damaged.
The levered players have a lot of work to do to have a chance for survival.
This is certainly no normal deleveraging.
It is instead the initial phase of the bursting of history’s greatest Bubble.
The first round got scary in a hurry.
With the system impaired, the next round risks all hell breaking loose.
“Hedge funds hit with steep margin calls.”
“Hedge Funds Log Historic One-Day Stock Selloff in Market Rout.”
“Investors Fear Another Big Blowup of Basis Trade as Treasuries Lose Haven Status.”
From the FT (Kate Duguid, Arjun Neil Alim, Harriet Agnew and Costas Mourselas):
“Hedge funds have trillions tied up in [Treasury ‘basis trade’] kind of strategy,’ he said.
“As things spiral, they’re being forced to sell anything they can — even good assets — just to stay afloat… if the Federal Reserve doesn’t step in soon, this could turn into a full-blown crisis.
It’s that serious.’ One hedge fund manager said: ‘Those huge hedge funds with trillions of dollars of Treasuries relative value trades will blow up today if the Fed doesn’t bail them out.’”
“Wall Street’s euphoria sends US stocks to historic gains after Trump pauses most of his tariffs.”
0 comments:
Publicar un comentario