Foreshocks
Doug Nolan
Stocks at new records this week, though not without more tremors forewarning of a major quake.
Most have grown comfortable with, and dismissive of, the stirring drumbeat of Foreshocks.
But some of us are darned worried about increasingly fragile fault lines and the eventuality of “the big one.”
The dichotomy between late-cycle speculative and liquidity excess versus a deteriorating Credit environment was front and center this week.
From central bankers to bankers to Credit investors and rating agencies - perceptions are shifting.
Discussions of weak underwriting and problematic market structure are no more confined to private conversations.
The word “Bubble” is no longer lunatic fringe.
Newfound scrutiny and resulting Credit tightening will prove problematic for scores of vulnerable borrowers and economic prospects more generally.
But major impacts materialize over time.
Meanwhile, liquidity overabundance persists in key markets.
In the near-term, incipient Credit problems have triggered a bond rally and declining market yields.
Global markets remain highly over-liquefied.
It’s as if festering U.S. Credit issues and rallying Treasuries have provided a meaningful jolt to global bond leveraging and liquidity.
Notable liquidity-generating short squeezes have unfolded in U.S., French and UK bonds.
Additionally, a more general unwind of hedges (against rising global market yields) provides a further liquidity boost.
The Japanese yen dropped another 1.5% this week, boosting October losses versus the dollar to 3.2%.
The weaker yen and the prospect of a more dovish BOJ could promote aggressive yen “carry trade” leveraging and resulting liquidity creation.
October 23 – Bloomberg (Liza Tetley and Nishant Kumar):
“Assets in the global hedge fund industry have surged to a record $5 trillion as investors poured money into alternatives and funds posted solid gains.
Hedge funds saw net inflows of nearly $34 billion in the three months through September, according to…
Hedge Fund Research…
That’s the most in any quarter since 2007, before the global financial crisis.
The surge in assets also came from investment performance, with total returns across all strategies averaging 5.4% over the quarter.”
It's worth noting that Money Market Fund Assets (MMFA) inflated another $30 billion this past week to a record $7.398 TN (1-yr growth $900bn, or 13.7%).
MMFA surged $191 billion over the past eight weeks, further extending historic monetary inflation that I associate with the expansion of leveraged speculation and attendant “repo” borrowings.
This dynamic has expanded into a global phenomenon over recent years.
Indicative of liquidity excess, major equities index gains this week included South Korea 5.1% (up 64.3% y-t-d), Japan 3.6% (23.6%), Hong Kong 3.6% (30.4%), and China 2.9% (17.9%).
Europe’s gains included the UK 3.1% (18.0%), Germany 1.7% (21.8%), Spain 1.7% (36.8%), Italy 1.7% (24.3%), and Sweden 3.2% (12.2%).
Notable outperforming, the (Hong Kong) Hang Seng China Financial Index’s 4.2% surge increased y-t-d gains to 31.9%.
This week’s advances pushed Europe’s STOXX 600 Bank Index to a 43.4% y-t-d gain, and Italian bank stock gains to 45.9%.
Lately, not much seems to irk Treasuries, including the Atlanta Fed GDPNow forecast, which remains elevated at 3.89%.
The preliminary October Manufacturing PMI was reported Friday at a slightly ahead-of-expectations 52.2, as the Services PMI added a point to a robust 55.2 (3-month high and 2nd highest reading over 10 months).
At 54.2, the composite PMI New Orders subcomponent was the strongest back to December 2024.
Friday’s slightly better-than-forecast CPI report (up 3.0% y-o-y) notwithstanding, elevated inflation risks live on.
Many Americans are now learning of significant increases to 2026 health insurance premiums, which go along with rising home and auto insurance costs.
Rising prices for so many things (i.e., imported goods, electricity, beef, coffee, food generally…) explain the (October final) University of Michigan Consumer Survey’s highly elevated 4.6% expected one-year inflation rate – along with 3.9% five-to-10-year expected inflation (rising from preliminary 3.7%).
Friday afternoon Drudge headlines:
“Govt Claims Inflation ‘3%’”; “Real or Fake?”; “Companies Shielded Buyers from Tariffs. Not for long…” “Poll: Cost-of-Living Worries Haunt Americans…” and “Beef Prices Soar…”
From Bloomberg: “US Inflation Comes in Soft, Building Case for More Fed Cuts.”
Treasury yields have declined 16 bps this month – and are now down 44 bps from July highs – to trade at one-year lows.
Market inflation expectations (5-yr “breakeven” rate) closed Monday at 2.32% - down 23 bps from the August high to near the low since April’s downdraft.
Interestingly, the five-year breakeven rate was back up to 2.40% by week’s end.
Replaying previous Bubble cycle dynamics, lower market yields have helped ameliorate incipient Credit concerns.
Expectations for a more assertive Fed rate-cutting cycle support the bullish narrative.
From my perspective, fledgling issues at the “periphery,” ensuring looser policies, are underpinning the booming “core.”
Investment-grade spreads to Treasuries at 75 bps, up only three bps from the multi-year lows of three weeks ago.
These are below where they began 2025 (80bps) and significantly down from April highs (119bps).
Meanwhile, “periphery” leveraged loan prices have barely recovered from First Brands-related selling.
Beginning the month at 97.06 (down from July’s 97.58 peak) and trading to 96.35 on October 14th, leveraged loan prices ended the week at 96.55.
October 24 – Bloomberg (Jeannine Amodeo):
“US leveraged-loan activity rebounded some from one of the slowest weeks of 2025, but this week is still poised to fall short of $10 billion in volume as leveraged - finance activity remains muted following a sizzling summer…
Amid the market’s broader sluggishness, loan funds had their first back-to-back weekly outflows since April, LSEG Lipper data show.”
October 24 – Bloomberg (Kyle Ashworth and Dorothea Quallis):
“The bankruptcy of First Brands and Tricolor Holdings has forced leveraged loan investors to pare risk.
The Bloomberg US Leveraged Loan Index (Loan Index) is heading for its first loss since April, as companies and consumers buckle under the impact of tariffs and rising costs.
The selective default rate for the benchmark has quadrupled in the past two years.
Managers of collateralized loan obligations are responding to accelerating credit rating downgrades by selling distressed issuers.”
October 24 – Bloomberg (Gowri Gurumurthy):
“US junk bonds are headed for modest weekly gains after yields fell by a mere two bps in the last four sessions and risk premium by just five basis points…
The US junk bond rally also lost some momentum as jittery investors pulled $970m from high-yield mutual funds, excluding exchange-traded funds, for the week ended Wednesday… the second straight week of cash outflows from US junk bond mutual funds...
The two weeks combined resulted in an outflow of $1.73b…
After a sudden burst of issuance this summer and a supply boom that made it the busiest September on record, the primary market has slowed, with issuance almost grinding to a halt.”
October 20 – Bloomberg (Rachel Graf and Olivia Fishlow):
“Exchange-traded funds that hold bundles of corporate loans last week notched their first outflows since April, in the latest sign that investor concerns over credit quality are mounting.
ETFs of collateralized loan obligations experienced an outflow of about $516 million last week, marking the first investor exodus in about six months, analysts at JPMorgan… wrote…
That compares to a weekly average of about $421 million of inflows over the past year…”
While mitigated in the markets by liquidity abundance and exuberance, there are important indications of heightened risk aversion and tighter underwriting for high-risk lending.
It is too early to assert a decisive reversal of speculative finance away from the “periphery,” though it’s moving in that direction.
October 20 – Financial Times (Ortenca Aliaj and Robert Smith):
“JPMorgan… has said that credit worries from the First Brands and Tricolor bankruptcies have driven up banks’ funding costs, with investors concerned about lenders’ hidden exposure to private capital firms and hedge funds.
The JPMorgan analysts made Monday’s comments about the implied cost of equity after last week’s sell-off of bank stocks, which was sparked by disclosures by two US regional lenders that they were exposed to alleged fraud by borrowers.
The high-profile collapses of car parts maker First Brands Group and subprime auto lender Tricolor Holdings within weeks of each other have highlighted the complex and often opaque financial arrangements between banks and ‘non-depository financial institutions’.
JPMorgan said banks’ lack of transparency about lending to such so-called NDFIs — a broad category that includes private equity groups, private credit firms and hedge funds — was pushing investors to demand higher compensation for owning their shares.
‘The recent global banks sell-off was triggered by poor risk management, in our view, as shown by First Brands supply-chain exposures but more importantly, very poor disclosure in relation to [NDFIs] globally across the banking system,’ JPMorgan analysts said…”
“High-profile collapses… have highlighted the complex and often opaque financial arrangements between banks and ‘non-depository financial institutions’.”
“Lack of transparency,” “poor risk management” and “very poor disclosure.”
A key passage from the above Bloomberg article:
“Regulators have become increasingly concerned about the interconnectedness of banks and NDFIs.
The IMF earlier this month warned of the need for greater oversight of the sector.
US and European banks are estimated to have $4.5tn of exposure to the wider category of non-bank financial institutions, equal on average to approximately 9% of total loan books.
The collapse of First Brands and Tricolor has shown how banks remain exposed to corporate crashes even when a company’s borrowing is largely outside the domain of traditional bank lending.”
Breakneck growth in leveraged lending, “private Credit,” and “junk” issuance constitutes a historic boom in high-risk lending.
It has been conspicuous – a Bubble that those responsible for safeguarding financial and system stability have disregarded.
As is too often the case, such excess is initially dismissed as fleeting financial folly without systemic ramifications – only for Bubbles to then inflate to the point where no one dares risk triggering a destabilizing bust.
Behind the scenes, there must have been heightened concerns, discussions, and perhaps even consternation – which finally enter public discourse after widening cracks reveal roach colonies.
October 21 – Financial Times (Martin Arnold and Ortenca Aliaj):
“Bank of England governor Andrew Bailey has said ‘alarm bells’ are ringing over risky lending in the private credit markets following the collapse of First Brands and Tricolor, as he drew a parallel with practices before the 2008 financial crisis.
The comments from Bailey underline the concern among regulators that the rapid demise of US car parts supplier First Brands and subprime auto lender Tricolor in recent weeks are a sign of financial strains in the complex private credit markets.
Referring to how repackaged financial products have in the past obscured the risk of the underlying assets, Bailey said: ‘We certainly are beginning to see, for instance, what used to be called slicing and dicing and tranching of loan structures going on, and if you were involved before the financial crisis then alarm bells start going off at that point.’”
I am compelled to further underscore Martin Arnold and Ortenca Aliaj’s important article:
“Private credit markets have become a critical source of funding for consumers and businesses as traditional banks have retreated since the financial crisis.”
“Wall Street’s practice of packaging subprime mortgages into asset-backed bonds fuelled the 2008 financial crisis, with years of loose lending standards leading to a crash in the value of these assets when US house prices fell.
In the run-up to the crisis, bankers and investors had regarded many such complicated financial products as virtually riskless.
The perception encouraged large institutions to borrow heavily against their holdings…”
Andrew Bailey:
“If you go back to before the financial crisis when we were having a debate about subprime mortgages in the US, people were telling us it was too small to be systemic.
That was the wrong call.
I’m not saying therefore the call should be the same this time but it underlines why the question is apposite.”
“Bailey’s comments follow a warning last week from the IMF that US and European banks’ $4.5tn exposure to hedge funds, private credit groups and other non-bank financial institutions could amplify any downturn and transmit stress to the wider financial system.”
“Sarah Breeden, deputy governor for financial stability…
‘We can see the vulnerabilities here, the opacity, the leverage, the weak underwriting standards, the interconnections.
We can see parallels with the global financial crisis. What we don’t know is how macro-significant those issues are.’”
Undoubtedly, “those issues” are of utmost macro-significance.
High-risk “private Credit” is said to have ballooned to $1.7 TN, though it’s surely much larger.
Besides, “private Credit” is only one component of this cycle’s high-risk lending boom.
Most importantly, this most protracted Credit Bubble has altered market, financial and economic structures.
In short, it has played an instrumental role in fostering today’s unprecedented wealth disparities.
This structure creates unappreciated systemic fragilities, including that the more unfortunate that have taken on so much debt during this cycle.
Then there are the financially fortunate that have benefited tremendously from asset inflation, whose borrowing and spending is now integral to sustaining asset Bubbles and the U.S. Bubble Economy more generally.
October 22 – Reuters (Arasu Kannagi Basil):
“U.S. banks’ loans to private credit providers have surged to nearly $300 billion, Moody’s said…, and the ratings agency warned that smaller lenders could face heightened risks if underwriting standards weaken.
Loans to non-depository financial institutions (NDFIs) are now 10.4% of total bank loans, nearly three times the 3.6% exposure a decade ago, the report said.
The aggressive growth outpaced all other lending activities since 2016, it added…
Besides exposure to private credit providers, there was a further $285 billion in loans to private equity funds as of June, and $340 billion in unutilized commitments available to these borrowers…”
October 23 – Bloomberg (Jeannine Amodeo):
“Banks are preparing to launch a $38 billion debt offering as soon as Monday that will help fund data centers tied to Oracle Corp. in what would be the largest such deal for artificial intelligence infrastructure to come to market, according to people with knowledge...
JPMorgan... and Mitsubishi UFJ Financial Group are among banks leading the deal…”
A Bloomberg Intelligence headline earlier in the week:
“AI Needs Push 2025 Tech Bond Issuance Toward Record $200 billion.”
The ongoing booming “core” has so far lavishly accommodated AI arms race financing demands.
Importantly, the all-powerful Bubble at the “core” of AI finance continues to underpin riskier AI borrowings, albeit through leveraged loans, “private Credit,” bank lending and such.
Moreover, AI manias and Bubbles have become integral to the markets (equities and debt) and U.S. and global economies more generally.
These dynamics create extraordinary vulnerability to any surprise market de-risking/deleveraging and associated liquidity issues.
There is no escaping today’s reality of unprecedented speculative leverage – especially prominent throughout equites (tech in particular), crypto, corporate Credit, derivatives and, of course, the Trillions of egregiously levered “basis trades” and “carry trades.”
Under the headline, “Fed’s Portfolio Unwind Gains Urgency as Markets Flash Warnings:”
October 24 – Bloomberg (Alexandra Harris):
“When Federal Reserve officials meet next week to decide whether to cut interest rates again, they’ll face another question that’s becoming increasingly urgent — how soon they should stop shrinking the bank’s $6.6 trillion portfolio of securities.
Money markets have been flashing warnings for several weeks that the process, known as quantitative tightening, may have run its course.
Now, Wall Street strategists say, stress signals have gathered such momentum that the Fed may be forced to end QT as soon as this month.
Since the central bank started reducing its portfolio in June 2022, more than $2 trillion in funds have left the financial system.
This has nearly emptied its main liquidity barometer — the reverse repurchase facility — just as a deluge of short-term debt issuance is luring more cash away.
In turn, a variety of interest rates used among banks to borrow and lend to each other have risen, while a tool introduced to dampen market pressures has seen regular use over the past week.”
More from Alexandra Harris’ insightful article: Quoting Mark Cabana, head of US interest rate strategy at Bank of America:
“You can make the case that there’s not just a risk that the Fed is at the in-between stage, but they’re there.
There’s a very small echo of 2019 and that the Fed over-drained cash and likely knows it.”
From Cabana and colleague Katie Craig:
“Money markets at current or higher levels should signal to the Fed that reserves are no longer ‘abundant.
By some metrics the Fed may also judge that reserves are no longer ‘ample’.”
And from JPMorgan strategists, led by Teresa Ho:
“The September 2019 turmoil revealed that the Fed has less tolerance for volatility in the fed funds rate and the ‘constellation of money market funds,’ committing the same mistake twice could have significant ramifications.”
Recent unusual upward pressure on overnight “repo” rates has Wall Street clamoring for the end of “QT” – the winding down of Fed balance sheet contraction in preparation for QE.
Repo market instability in the summer of 2019 saw the Fed aggressively restart QE months ahead of the pandemic.
It’s worth noting that the Fed’s balance sheet bottomed at $3.76 TN in late-August 2019 - ending the year at $4.166 TN and on its way to $7.165 TN by early June and an April 2022 peak of $8.965 TN.
Fed Assets are today $6.59 TN, which is apparently, in the eyes of Wall Street, increasingly insufficient.
Recent “repo” market tightness is a critical piece of today’s puzzle.
Is it, as it was in the summer of 2019, an initial sign of vulnerability and risk aversion within a leveraged speculating community way too far out on its skis?
October 24 – Bloomberg (Justina Lee and Denitsa Tsekova):
“Behind the scenes of placid Wall Street markets, drama is unfolding for some heavy-hitting professional investors.
Quantitative funds are suffering this month amid reversals in crowded and previously money-minting positions.
The risks in stretched momentum trades were laid bare this week in sessions like Wednesday, when high-flying gold, tech shares and crypto were torpedoed all at once.
Quant long-short funds are down 1.7% in October, posting their first losses since another big bout of volatility in July…
The $20 billion Renaissance Institutional Equities Fund lost about 15% through Oct. 10…
In one brutal example, a long-short Morgan Stanley basket tracking momentum stocks slid 11.3% over the five days ending Wednesday, the sharpest decline since March…
A Goldman basket of the market’s most-shorted stocks saw its October month-to-date gains reach 21% at one point — likely hurting hedge funds…”
From the above article, a quote from Richard Craib, founder of hedge fund Numerai:
“‘Junk rallies’ hurt quants because they are often short low-quality stocks and long high-quality stocks.
If the damage gets big enough, quant funds start to delever to cover their shorts, making matters worse and leading to a deleveraging cascade.”
The Goldman Sachs Most Short Index jumped 2.5% Friday, extending an 11-session stretch of remarkable volatility.
Over the previous 10 sessions, the index rose 2.0%, dropped 4.5%, fell 2.7%, surged 4.1%, dropped 2.8%, sank 4.7%, jumped 4.3%, rose 2.4%, surged 5.8%, and sank 4.1%.
Not healthy.
Market action suggests quant fund deleveraging.
There is potential for “a deleveraging cascade.”
But in speculative marketplaces – the current backdrop in particular – signs of a short squeeze provide a rallying cry to aggressively buy stocks, ETFs, and, for the best bang for the buck, call options.
Free money.
At October 16th highs, the GS Short Index had surged 37% in six weeks - and was 122% above April lows.
If one was envisaging a scenario for a major top, we’re seeing it.
Between extraordinary happenings in Credit, “repo,” “quants,” short stocks, the metals markets, and global equities, there are clearly acute instabilities festering below the markets’ “resilient” veneer.
Pressures are building.
I’m on liquidity and “earthquake” watch.
It has that feel of de-risking and deleveraging Foreshocks.
Between the Fed and the Trump/Xi meeting, next week will be another interesting one.
I find myself this evening pondering whether the President’s deployment of our largest aircraft carrier and strike group as a show of force in Latin America, new Russian sanctions, and his Canada Reagan “fraud” tantrum have Xi Jinping either more or less inclined to give Trump a trade negotiation win next week in South Korea.
Things get more alarming and destructive by the week.
For Posterity:
Friday from the President:
“THE STOCK MARKET IS STRONGER THAN EVER BEFORE BECAUSE OF TARIFFS!”
“THE UNITED STATES IS WEALTHY, POWERFUL, AND NATIONALLY SECURE AGAIN, ALL BECAUSE OF TARIFFS! THE MOST IMPORTANT CASE EVER IS IN THE UNITED STATES SUPREME COURT. GOD BLESS AMERICA!!!”
“CANADA CHEATED AND GOT CAUGHT!!!
They fraudulently took a big buy ad saying that Ronald Reagan did not like Tariffs, when actually he LOVED TARIFFS FOR OUR COUNTRY, AND ITS NATIONAL SECURITY.
Canada is trying to illegally influence the United States Supreme Court in one of the most important rulings in the history of our Country.
Canada has long cheated on Tariffs, charging our farmers as much as 400%.
Now they, and other countries, can’t take advantage of the U.S. any longer.
Thank you to the Ronald Reagan Foundation for exposing this FRAUD.
MAKE AMERICA GREAT AGAIN!!!”
CNN’s Erin Burnett (October 22, 2025):
“When the White House says this ballroom is just another renovation… just one in a long line, is there any truth in that?”
Edward Lengel, former Chief Historian, White House Historical Association:
“First of all, I’ve got a lot of attention from media outlets all around the world who are very interested – and very upset – by what’s going on.
So, we’re sending the wrong image abroad. But the administration’s talking point that this is like any other change is absolutely disingenuous.
And it’s a misdirection, because they’re suggesting anybody who criticizes this is just a stick in the mud – they don’t want change.
The issue is that this addition turns the White House and the Executive Mansion into something that it is not.
It is no longer the People’s House.
It is no longer in tune with what the founders intended.
And it’s no longer in tune with the history of our country.
It sends the wrong message.”
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