Asian-Crisis-in-Reverse Feel
Doug Nolan
Sure got the old neck stuck out this time.
Markets have rallied, financial conditions have loosened, and debt markets have reopened. I’m not dissuaded.
The great Bubble is in trouble.
It was 15 months from the June 2007 (subprime eruption) mortgage finance Bubble piercing to the cataclysmic 2008 crisis.
Over that drawn out “process,” crisis dynamics at the “periphery” ebbed and flowed as they gravitated toward the precious “core.”
Aggressive rate cuts and various measures somewhat impeded the process, yet nothing could alter the reality of Trillions of suspect debt, egregious speculative leverage, and associated fatal market structure issues (i.e., derivatives and the “repo” market).
There was no rectifying acute financial and economic fragilities that had accumulated over the Bubble period.
Crisis dynamics take fateful turns when perceived safe and liquid “money” succumbs to a crisis of confidence and panic.
Historically, bank runs triggered acute financial and economic crises.
In September 2008, it was a panicked run on “money,” more specifically Lehman Brothers and Wall Street “repo” liabilities.
Today’s crisis dynamics have key differences from 2008.
In general, market-based mortgage Credit had a significantly outsized role in total system Credit going into 2008.
This created latent vulnerability to the reversal of speculative flows and deleveraging, along with an associated tightening of market financial conditions.
At the same time, the “core” was underpinned by rock solid perceptions of “moneyness” for Treasuries, Federal Reserve Credit, and the dollar more generally.
The robust “core” afforded Washington extraordinary crisis-fighting capacity that should no longer be taken for granted.
In one respect, today’s Credit dynamics seem more robust.
Massive fiscal deficits ensure system Credit growth remains dominated by the expansion of “core” Treasury securities.
This, at least initially, insulates Credit expansion from the type of “risk off” market dynamics and reversal of speculative flows that doomed the mortgage finance Bubble back in the second half of 2007.
Relative stability at the “core” initially stalled crisis dynamics that erupted at the “periphery.”
But there is today an important caveat.
This cycle’s egregious excesses – over-issuance, speculative leverage, and Credit debasement – have flourished at the “core” – especially within Treasury and agency securities markets.
Moreover, there are serious issues associated with another key “core” Credit component – Federal Reserve liabilities.
After ending 2007 at about $900 billion, total Fed assets today weigh in at $6.7 TN.
System stability today lacks the paramount underpinnings provided by a strong foundation.
Ending June 2007 at 72.5, the dollar index rallied to a high of 88.5 on November 21st, 2008.
From September 2007 to late October 2008, the Fed slashed rates 425 bps to 1%, but the dollar index rallied 10% during that period.
And from June 2007 highs (5.30%) to the end of October 2008, 10-year Treasury yields sank 135 bps.
Yields collapsed as the Fed cranked up QE, ending the year at 2.21%.
Today’s Treasury market behaves differently, fitting considering Treasury securities inflated (526%) from $4.5 TN to end 2007 to the $28.1 TN 2024 close.
Longer-term Treasury bonds underperformed again this week.
Ten-year yields rose seven bps to 4.39%, compared to the three bps increase in German bund yields (2.56%) and two bps rise in French (3.27%) and Spanish (3.21%) yields.
Curiously, over the past six weeks of global market instability, 10-year Treasury yields were up 13 bps, while bund yields fell 17 bps.
Meanwhile, the dollar index is down 3.5% over six weeks.
May 6 – Reuters (Rae Wee):
“Taiwan’s currency is at three-year highs after notching unprecedented gains as insurance firms, pension funds and other investors quit U.S. dollar assets or scramble to hedge exposure.
Analysts estimate billions of dollars’ worth of hedging or repatriation by life insurance firms could drive the Taiwan dollar even higher.
The latest scramble by Taiwanese life insurers to protect their portfolios reflects an unwinding of massive U.S. dollar holdings by global investors, as U.S. President Donald Trump’s chaotic trade policies shake decades of unquestionable faith that investors had in the dollar’s dominance.”
After the May 1st close at 32.00, the U.S. dollar versus the Taiwan dollar sank 7.5% in two sessions to 29.6.
Bloomberg headline: “Taiwan’s Markets Jolted as Currency Surges Most Since 1980s.”
Monday’s jump was the biggest gain since the 2008 financial crisis.
Taiwan’s central bank intervened to stabilize trading.
As they tend to do, years of artificial stabilization measures fostered a market structure prone to an eruption of instability and dislocation.
Last August’s yen “carry trade” and derivative “swaps” eruption was an important development.
Recent “swaps” market turmoil provides additional key evidence of serious market structure issues.
And I see this week’s panic buying of Taiwan’s currency as further evidence of underlying global Bubble fragility.
May 6 – Reuters (Rae Wee and Samuel Shen):
“A wave of dollar selling in Asia is an ominous sign for the greenback as the world’s export powerhouse starts to question a decades-long trend of investing its big trade surpluses in U.S. assets.
Ripples from Friday and Monday’s record rally in the Taiwan dollar are now spreading outward, driving surges for currencies in Singapore, South Korea, Malaysia, China and Hong Kong.
The moves sound a warning for the dollar because they suggest money is moving into Asia at scale and that a key pillar of dollar support is wobbling…
‘To me, it has a very sort of Asian-crisis-in-reverse feel to it,’ said Louis-Vincent Gave, founding partner of Gavekal Research… due to the speed of the currency moves.”
An unfolding dollar crisis of confidence is integral to the faltering Bubble thesis.
The dollar index dropped 2.8% during peak deleveraging week April 11th, with “liberation day” unleashing a three-week drubbing (down 5.9% at April 21st lows).
Importantly, the dollar index sank 3.5% the week following President Zelenskyy’s Oval Office humiliation – the largest weekly decline since November 2022.
The Trump administration has been a crisis of confidence catalyst.
Market structure that solidified over years of Bubble excess has turned highly problematic.
Decades of unrelenting U.S. Current Account deficits led to an unprecedented accumulation of dollar holdings across the globe.
Powerful “core” (i.e., Treasuries and the Fed balance sheet) stabilization dynamics underpinned U.S. markets, incomes and corporate earnings, and economic growth – all working together to ensure the dollar maintained its unrivaled reserve currency stature.
Speculative blow-off dynamics that took hold after the March 2023 bank bailout, culminating in the historic AI mania, elevated “American exceptionalism” and “king dollar” to unsupportable maniacal heights.
Now the hangover.
May 8 – Bloomberg (Ruth Carson):
“The dollar may face a $2.5 trillion ‘avalanche’ of selling as Asian countries unwind their stockpile of the world’s reserve currency, according to Stephen Jen.
Asian exporters and investors may have amassed an ‘extremely large’ pile of dollars through the years, widening the region’s trade surplus with the US, Eurizon SLJ Capital’s Jen and Joana Freire wrote...
As a US-led trade war deepens, some Asian investors might repatriate chunks of funds or ramp up levels of protection against a weakening dollar — potentially triggering an exodus from the world’s reserve currency.
‘We suspect these dollar hoardings by Asian exporters and institutional investors may be extremely large – possibly on the order of $2.5 trillion or so – and pose sharp downside risks to the dollar vis-à-vis these Asian currencies,’ Jen and Freire wrote.”
May 6 – Bloomberg (Shuli Ren):
“As Asians liquidate their dollar assets and repatriate the proceeds, the unwind can be chaotic.
However, that Taiwan’s currency extended its rally despite the central bank’s strenuous effort to calm markets points to something more structural.
Wealthy, export-oriented Taiwan, for one thing, is engaged in a massive carry trade.
In recent years, the domestic life insurance industry, a big business that is estimated to hold assets equivalent to 140% of gross domestic product, found that it could profitably borrow locally and shovel the proceeds into US dollars.
At their peak, insurers were buying more than $50 billion in US assets a year, according to the Financial Times.
Life insurance companies invest close to 70% of their money in foreign assets, but 83% of their funding is in the Taiwan dollar, according to Bank of America Merrill Lynch.”
Louis-Vincent Gave’s comment from the above Reuters article resonates:
“To me, it has a very sort of Asian-crisis-in-reverse feel to it.”
The 1995 Mexican bailout triggered speculative “blow-off” flows that pushed “Asian Tiger” Bubbles to precarious “terminal phase excess”.
Currency weakness that quickly escalated into the July 1997 Thai baht dislocation unleashed crisis dynamics, soon to engulf the entire region in most devastating financial and economic crises.
Massive speculative positions accumulated during the enticing boom period.
The reversal of flows quickly turned destabilizing.
A frantic “hot money” exit soon depleted central bank international reserves.
This sparked a panicked exodus from the entire region, with illiquidity, market dislocation, and absolute mayhem.
To what extent the Trillions of Asian (and global) flows over recent years into U.S. financial assets should be considered “hot money” is open to debate.
But much was on the assumption of security, liquidity, stability, the rule of law and, generally, “U.S. exceptionalism.”
America was viewed as unrivaled for financial, economic, and political stability.
Washington – the three equal branches of government, the Federal Reserve, American norms and ideals – was perceived as ensuring enduring stability.
Shifts in critical perceptions are integral to the bursting Bubble thesis.
May 8 – Bloomberg (Arjun Neil Alim, Cheng Leng, William Sandlund and Joseph Cotterill):
“Asian investors have been rushing to shield themselves from big swings in the US dollar, putting upward pressure on their local currencies and forcing Hong Kong authorities to intervene in the market.
Taiwan’s dollar has surged almost 6% against the greenback this month, posting the biggest single-day moves since the 1980s, while Hong Kong’s monetary authority spent the largest weekly amount since 2020 to stop the city state’s currency strengthening beyond a US dollar peg.
‘It is not even once in a decade — it has been a once in a lifetime event.
It has been an extraordinary move’ in the Taiwan dollar in particular, said Mark Ledger-Evans, a portfolio manager at… Ninety One.
The moves reflected uncertainty over what Chinese manufacturers, Taiwanese insurers and other Asian investors will do with the trillions of dollars of US assets built up due to surging exports to the US.
These assets are now hostage to a weakening greenback.”
May 9 – Bloomberg (Chanyaporn Chanjaroen and Diana Li):
“Some of Asia’s richest families are cutting exposure to US assets, saying President Donald Trump’s tariffs have made the world’s largest economy much less predictable.
One family office managing assets for Chinese billionaires exited its US holdings entirely and will shift the proceeds to Asia.
A senior executive at one of Europe’s largest private banks said the scale of the recent selloff from rich clients and institutions around the world is unprecedented over the past three decades and could be the beginning of a more persistent shift.
A top bank executive in Asia got rid of 60% of US assets from his own portfolio, saying it’s safer to hold cash and gold.
About 10 family offices and advisers to the ultra-rich who oversee billions of dollars told Bloomberg News they’re reducing their exposure or freezing investments, mostly in US equities and Treasuries.
They cite rapid policy shifts, uncertainty and the risk of a recession…
‘For the first time, some families are considering partial divestment from US holdings,’ Henry Hau, chief executive officer of Hong-Kong based Infinity Family Office, said…
‘These families weathered the dot-com bubble, the Asian financial crisis, and the 2008 global crisis while maintaining faith in US assets.
Now, however, they are exploring reallocating 20%-30% of their US portfolios to China and Europe.’”
It is important to connect the “swaps” market dislocation a few weeks back to this week’s Taiwanese dollar tumult.
Tens of Trillions of risk have been (or plan to be) offloaded to derivatives markets.
“Swaps” markets are key to hedging both interest-rate and currency risks – of which there are tremendous amounts in today’s dollar and Treasury markets.
If Asian holders of Treasuries and other dollar assets move to de-risk, it’s unclear who will “take the other side of the trade.”
As enormous amounts of risk are offloaded to the derivatives markets, it's unclear what buyers will materialize when market weakness forces powerful self-reinforcing derivatives-related selling.
Recent interest-rate “swaps” instability in concert with a spike in Treasury yields was an important “canary.”
The unparalleled expansion of Treasury debt over the past 16 years has created untenable risks that cannot be transferred to/hedged in derivatives markets.
Faith in the functioning of derivative markets is in jeopardy, creating vulnerability to market illiquidity and dislocation.
Last summer’s (yen) and this week’s (Taiwan dollar) currency market dislocations are “canaries.”
A massive currency mismatch, having developed over decades, is increasingly untenable.
There’s way too much exchange-rate risk to transfer/hedge in “swaps” and currency derivatives marketplaces.
Markets risk illiquidity and dislocation.
Is it reasonable that Taiwan’s insurance companies – that have ballooned over recent years – will hold firm with their strategy of accepting U.S. dollar risk against insurance policies denominated in their local currency?
A suspect strategy has finally turned problematic.
Gradually, then suddenly.
The first of many.
Acute market instability forced the administration’s hand.
There was the tariff pause, along with Powell’s stay of execution.
The President is seen as retreating from his aggressive tariff intentions to placate fragile markets.
A steady drumbeat of positive headlines has buoyed market sentiment, including this week’s U.S./UK trade deal.
Prospects of U.S. and Chinese officials entering negotiations and ending the current virtual trade embargo provided hope for a thaw in relations.
Vulnerable markets have coaxed a bout of best behavior.
But I doubt the President is ready to negotiate away his lofty tariff aspirations.
For now, it’s in both parties' interests to present a constructive beginning to such important talks.
Today’s exorbitant tariffs will be significantly reduced – and I assume cargo ships will be loaded up to begin their voyages across the mighty Pacific.
Both sides will smile, partake in niceties, and offer hopeful headlines, while gearing up for protracted bare-knuckles hardball tactics.
And this fraught relationship, with momentous ramifications, is integral to the burst Bubble thesis.
Whether U.S./China trade restarts soon will likely not meaningfully impact the momentous upheaval unfolding with the post-WWII world order.
May 7 – Financial Times (Joe Leahy and Max Seddon):
“Xi Jinping has drawn a parallel between modern-day US ‘hegemony’ and the ‘arrogant fascist forces’ of 80 years ago, ahead of Thursday’s Moscow summit with Vladimir Putin and second world war Victory Day celebrations.
The Chinese and Russian presidents are using the meeting to signal the strength of their alliance against the US-led international order, as President Donald Trump unleashes tariffs on Beijing and tries to push Moscow towards a peace deal with Ukraine.
Putin hailed Xi as his ‘dear friend’… the summit… got under way.
Putin added that he would visit China this year for celebrations marking the anniversary of Japan’s defeat in the second world war.
Xi added that China and Russia would work together to ‘decisively defend the interests and rights of our states and all developing countries… form an equal, balanced multi-polar world and inclusive, accessible economic globalisation’.”
Xi Jinping has serious domestic considerations.
He needs to keep his massive manufacturing apparatus in constant motion.
And I doubt Beijing is comfortable with the prospect of a strengthening currency.
But Xi surely recognizes today’s extraordinary U.S. vulnerabilities and the strategic opportunity that a crisis of confidence in the dollar and American markets present.
Unlike other countries, the U.S. doesn’t have international reserves to use for timely currency interventions.
But who needs reserves when you have QE?
This is where the analysis turns “interesting.”
Inflation is already elevated, with high tariffs in the offing.
The Fed is poised to be slow and likely stingy with the next round of market liquidity assistance.
But a problematic scenario seems to have evolved from a remote to a real possibility:
Would a disorderly dollar decline restrain the Fed’s QE crisis response?
And how might the Treasury market respond to a faltering dollar coupled with an inhibited Federal Reserve (less appetite for huge Treasury purchase programs)?
Or, how might the dollar and Treasury market respond to aggressive QE with both under pressure?
Might aggressive QE just work to create additional liquidity intent on exiting dollar assets – the dynamic that precludes EM central banks from QE crisis responses?
Things could turn sour with a faltering dollar, a tariffs and weak currency-induced upside inflation surprise, surging Treasury yields, and all the de-risking/deleveraging that such a scenario would unleash.
Seeing all the ingredients for an evolving crisis of confidence, there’s little to justify a retreat from the bursting Bubble thesis.
This historic Bubble was fueled by unprecedented Credit inflation at the foundation – the “core” - of global finance.
To that end, highly destabilizing crises erupt when perceptions of safety and liquidity suddenly shift to fear and then panic.
Latent fragility lives dormant in the realm of perceived money-like debt instruments.
If international confidence in the dollar has waned and speculative flows have reversed, the highly levered Treasury market is increasingly vulnerable.
History informs us that faith in “money” is all-powerful - until it isn’t.
Gold jumped $84 this week to $3,325.
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