It's Back
Doug Nolan
Global bond yields continued their march higher – Germany, Portugal, Italy, and Greece another six bps.
Ten-year Treasury yields gained five bps to a three-month high of 4.18%.
The cryptocurrencies were back under pressure late in the week.
Gold surged $102 and Silver 6.2% - to record highs.
Meanwhile, cracks in the AI mania are increasingly discernible.
December 11 – Bloomberg (Caleb Mutua):
“Oracle Corp.’s new investment-grade notes are now trading more like junk bonds, as delays on the completion dates for some data centers add to fears about profits from its artificial intelligence investments…
Meanwhile, the cost of protecting Oracle’s debt against default rose as much as 14.4 bps on Friday to 151.3 bps…
The measure is poised to finish at its highest level since 2009 for a second-straight session.
Oracle is among tech bellwethers borrowing heavily in the public and private debt markets to finance AI efforts.”
Financial conditions: zero.
Credit: zero.
Leveraged Loans: zero.
Leverage: zero.
Hedge funds: zero.
Basis trade: zero.
Bonds: one.
How is it that such critical topics garner not even a mention?
Today’s extraordinary environment demands much more from the journalists asking questions at Chair Powell’s post-meeting press conferences.
Blackrock's Jeffrey Rosenberg provided valuable post-press conference analysis (Bloomberg TV):
“The piece that’s missing from this conversation, however, is financial conditions.
And that if your goals are conflicting – and it’s sort of a tie – I think you break the tie with financial conditions.
But they’re just not discussing that at all anymore, which could come back to haunt them.
That’s the piece of the conversation.
(Bloomberg’s) Mike Mckee, maybe next press conference, it will be interesting to ask that question.
Because they used to talk about it all the time.
The whole point of the balance sheet was portfolio rebalance.
The impact of the k-shaped recovery - they’ve had a lot to do with that in terms of the wealth effect - is supported by the balance sheet and the Fed’s activities.
They absolved themselves of any of that.
I think there’s more there to unpack.”
Much more to unpack.
It might not yet be obvious to most, but years of excessively loose conditions have come back to haunt the system.
And for the Federal Reserve to “absolve” itself from the whole issue is a dereliction of its responsibility to safeguard system stability.
Jeffrey Rosenberg is one of the outstanding macro thinkers of this period.
If “it’s sort of a tie” between the stable prices and full employment mandates, “you break the tie with financial conditions.”
I’ll go further.
If inflation has remained above target for going on five years, responsible central bank management dictates prudent focus on financial conditions.
In elevated inflationary environments, odds favor upside inflation persistence and upside surprises.
Moreover, the longer inflationary pressures are accommodated by loose conditions, the greater the eventual tightening that must be imposed to break inflationary biases and psychology.
As for the full employment mandate, I would argue it’s today sort of a tie between evidence of resilience versus downside risks.
Here again, financial conditions are key.
With a 4.4% unemployment rate (September), a much stronger-than-expected 7.658 million job openings (October), and ongoing historically low weekly unemployment claims, loose conditions significantly reduce the near-term risk of labor market weakness.
From this angle, financial conditions analysis would underscore the focus on the price stability mandate.
Most importantly, the Federal Reserve’s overarching responsibility to safeguard monetary and system stability dictates a sound financial conditions analytical framework and management approach.
This is an area where contemporary central banking has completely broken down.
Repeated massive QE programs and years of loose “money” accommodation unleashed speculative forces that came to dominate global finance.
And it is leveraged securities speculation that today largely dictates financial conditions.
“Risk on” leveraged speculation stokes self-reinforcing liquidity excess.
Lurking “risk off”, meanwhile, risks triggering deleveraging, illiquidity, market dislocation, and panic.
The Fed has slashed rates 175 bps in 15 months, despite extraordinarily loose financial conditions.
Such accommodation pushed Bubble excess to speculative blow-off extremes – AI, leveraged lending, private Credit, crypto, M&A, etc.
Money Market Fund Assets, my proxy for the expansion of “repo” financed levered speculation, have inflated $1.352 TN, or 21.4%, since the Fed began easing monetary policy (9/18/24).
The past 19 weeks' $579 billion, or 22% annualized, expansion pushed the historic three-year monetary inflation to $3.023 TN, or 65%.
December 10 – Financial Times (Kate Duguid and Claire Jones):
“The Federal Reserve has said it will launch a $40bn short-term bond-buying programme just weeks after it stopped shrinking its balance sheet following repeated bouts of strain in money markets.
The US central bank said… it would begin purchasing Treasury bills… starting on December 12.
Its decision comes after interest rates in overnight lending markets jumped last month…
Some Fed officials had expressed concern that rates in the repo market, which forms a vital part of the financial system’s plumbing, had repeatedly become unmoored from other borrowing costs the central bank sets.”
December 11 – Bloomberg (Alex Harris):
“The Federal Reserve’s plan to buy $40 billion of Treasury bills a month, a bigger chunk than previously expected, triggered a flurry of revisions in Wall Street banks’ 2026 debt issuance forecasts while sending borrowing costs lower.
The central bank said it will start buying bills Friday in a bid to ease short-term interest rates by rebuilding reserves in the financial system.
Barclays estimates the Fed could wind up buying close to $525 billion of T-bills in 2026 from a previous forecast of $345 billion, with net issuance to private investors estimated at just $220 billion from $400 billion previously.”
QE is back, unsurprisingly.
Chair Powell:
“As a separate matter, we also decided to initiate purchases of shorter-term Treasury securities solely for the purpose of maintaining an ample supply of reserves over time, thus supporting effective control of our policy rate.”
“In light of the continued tightening in money market interest rates relative to our administered rates, and other indicators of reserve market conditions, the Committee judged that reserve balances have declined to ample levels.
Accordingly, at today’s meeting, the Committee decided to initiate purchases of shorter-term Treasury securities (mainly Treasury bills) for the sole purpose of maintaining an ample supply of reserves over time.”
“So, we knew [tighter funding market conditions] was going to come.
When it finally did come, it came a little quicker than expected, but we were absolutely there to take the actions that we said we would take.
So, we took those actions are today.
We announced that we’re resuming reserve management purchases.
That is completely separate from monetary policy.
It’s just we need to keep an ample supply of reserves out there.”
“Completely separate from monetary policy” – really?
It’s worth noting that Fed assets have inflated from $3.77 TN to $6.54 TN ($2.77 TN, or 73%) since the Fed restarted QE in September 2019.
A good question would be why today’s still inflated Fed balance sheet is insufficient from a system liquidity perspective?
And at $40 TN a month, the latest QE program is formidable.
The FMOC is clearly hoping that a shot of liquidity will help stabilize the “repo” market, while somewhat easing year-end funding pressures.
The problem is that previously impactful $40 TN Fed liquidity operations these days confront massively inflated “repo,” funding, and derivative markets, not to mention the enormous “basis trade” and speculative leverage that has ballooned over the past three years.
December 8 – Bloomberg (Alexandra Harris):
“Sponsored repo activity, in which dealer-banks net two sides of a trade and hold less capital against it, spiked to a record as firms maneuver to take pressure off their balance sheets.
As a result, the overnight market for repurchase agreements ease.
Transactions totaled to an all-time high $3.26 trillion as of Dec. 5, from $2.67 trillion the prior session…
The roughly $593 billion increase is the largest ever and the $3.26 trillion surpasses the previous record of $2.77 trillion reached on Dec. 1.
Repo pressures tend to climb toward the end of the year as banks pare their activity in order to shore up their balance sheets for regulatory purposes, pushing cash out of the private space.
In addition, dealer holdings of Treasuries reached a record $473 billion…”
December 8 – Bloomberg (Alice Atkins):
“A surge in hedge-fund bets in US interest-rate swaps risks a repeat of the kind of volatility markets saw in April, according to the Bank for International Settlements.
The funds have ramped up exposure to Treasuries since the second quarter of 2024, largely through the so-called swap trade, as the popular cash-futures basis trade has stagnated, the BIS said…
The strategy involves raising funds in the repo market to buy cash bonds while simultaneously shorting the comparable interest-rate swap to exploit discrepancies in price.
The size of the trade reached $631 billion in the second quarter of this year, up from $281 billion in the first quarter of 2024, the paper said.”
I understand why Fed officials are happy to avoid discussing financial conditions.
Furthermore, it might be convenient to just extricate QE from the monetary policy discussion.
But the issue of the Fed’s liquidity backstop is now more critical to markets than ever.
Stocks rallied and the 10-year Treasury yield declined four bps Wednesday on the news of a larger-than-expected QE program.
Of course, the Fed would restart QE as soon as securities funding markets began to turn unstable.
The critical issue today is not insufficient reserves.
The problem is system fragility caused by a massive increase in speculative leverage.
The surge in speculator borrowings creates self-reinforcing system liquidity that fuels asset inflation, speculative excess, and perilous Bubbles.
But this structure is inherently fragile.
It malfunctions in reverse, with deleveraging leading to liquidity destruction and market dislocation.
I wrote in 2019 that the QE restart was a major policy error.
At the time, repo instability was an important market mechanism ready to impose some discipline and disincentivize speculative leveraging.
The seemingly stabilizing effect of Fed QE was actually highly destabilizing, as was made clear with the scope of March 2020 deleveraging and near financial meltdown.
The Fed’s $5 TN pandemic QE program was a monetary fiasco.
QE has been fundamental to financial, market, economic, and social maladjustment: Inflation, asset price Bubbles, inequality and the “k-shaped” economy, social and political strife.
More specifically, QE fueled the historic AI mania and arms race, the cryptocurrency Bubble, and speculative Bubbles more generally.
Arguably, QE’s most consequential impact has been the perception of unassailable “repo” rate and liquidity stability.
To be sure, confidence in the Fed’s “repo” market liquidity backstop has been fundamental to the proliferation of highly levered “arbitrage” and “relative value” trading strategies that profit from small but reliable spreads between instruments (i.e., “basis trade”/ Treasuries vs. futures, Treasuries vs. swaps, higher-yielding MBS/corporate bonds/ABS vs. Treasuries).
At some point, a most perilous Bubble dynamic takes hold.
This occurs when a Bubble has inflated to the point where market operators realize that highly elevated systemic risk guarantees rapid and forceful central bank responses to waning liquidity and faltering Bubbles.
One could argue this juncture was reached in late-2022 (gilt-led bond deleveraging) to early-2023 (Silicon Valley Bank/SVB collapse and bank run). T
he Fed/GSE’s rapid $500 billion SVB liquidity response was integral to the ongoing historic speculative leveraging “blowoff”.
Resulting liquidity distortions have been monumental.
Beyond market excess, liquidity overabundance has accommodated egregious Washington deficit spending.
Trillions of speculative leverage shelved the imposition of market discipline on our reckless spendthrift government (of both parties).
Years and decades of monetary inflation and leveraged speculation have created today’s intractable predicament: frighteningly too much “money” aggressively engaged in speculative finance.
It’s one colossal Bubble comprised of Crowded Trades virtually everywhere.
Markets are dysfunctional, dysfunctionality that has been largely masked by “blowoff” speculative excess and resulting liquidity overabundance.
Now, however, pockets of de-risking and deleveraging have begun to emerge.
Key hedge fund strategies are faltering, illuminating serious Crowding issues.
Resulting volatility and instability will lead to a problematic cycle of speculative deleveraging.
December 12 – Wall Street Journal (Gregory Zuckerman and Peter Rudegeair):
“Unprecedented turbulence at a pair of quantitative hedge funds managed by the industry pioneer Renaissance Technologies is causing the firm to consider adjusting its trading models, according to people familiar...
The… firm, founded by the mathematician Jim Simons, uses machine learning and predetermined algorithms to bet on and against thousands of stocks at any given time.
Renaissance told clients it is weighing an adjustment in its trading models after the two funds, which together manage nearly $20 billion, suffered their worst months ever in October before surging in November.
Renaissance’s investing algorithms weren’t prepared for recent, unusual moves in the shares of some small companies, including so-called meme stocks, people… said.
The famously secretive firm is now examining ways to reduce the volatility of these funds, the people said.”
December 8 – Bloomberg (Marcus Ashworth):
“Regulators are finally starting to appreciate how much major government debt markets are being dominated by a handful of hedge funds.
There’s a head of steam building around the issue; the Bank for International Settlements released an important analysis last week of the leverage involved, with the Bank of England's December Financial Stability Report also highlighting the risks to financial stability posed by the trading strategy.
But we need to be careful about letting the air of out of this bubble.
What’s clear from both reports is that central bankers don’t have a coherent plan for reducing the leverage that’s metastasized in sovereign bonds in recent years.
Asking nicely hasn’t worked; the dilemma is how to get hedge funds to suddenly reduce their market share without triggering a market meltdown…”
It just has the feel of the walls starting to close in.
The cryptocurrency Bubble is faltering, with vulnerable tech/AI Bubbles shadowing somewhat behind.
Speculative leverage is on the regulator radar.
Meanwhile, the midterms are now only 11 months away, as Trump politics suffers cataclysmic degradation.
We should fully expect the administration to painstakingly pull out all the stops – no matter how unconventional or outrageous.
December 11 – New York Times (Alan Rappeport and Colby Smith):
“The Trump administration accelerated its deregulatory push… by asking the Financial Oversight Stability Council, a financial crisis-era government panel that monitors threats to the financial system, to take steps to ease regulations that they claim are strangling economic growth.
The focus on deregulation comes as President Trump looks to jump-start economic output ahead of midterm elections next year…
The loosening of regulations has been described by Mr. Trump’s advisers as the third pillar of his plan to unleash the nation’s economic potential.”
December 11 – CNBC (Steve Liesman):
“Treasury Secretary Scott Bessent is proposing a major change in how the government approaches financial regulation and stability…
In a letter set to be released…, Bessent will recommend altering the approach of the Financial Stability Oversight Council.
Whereas the agency’s focus had been tightening regulations and oversight of the institutions it oversees, the new plan will switch that, and push for looser regulation and a freer approach.
The letter will say, ‘the Council will work with and support member agencies in considering whether aspects of the U.S. financial regulatory framework impose undue burdens and negatively impact economic growth, thereby undermining financial stability’.”
December 11 – Bloomberg (Daniel Flatley):
“Treasury Secretary Scott Bessent said he would continue his campaign to reduce financial regulations, highlighting the Trump administration’s effort to bolster economic security amid concerns over persistent inflation and affordability.
‘Economic growth is critical to financial stability,’ Bessent said in a letter accompanying the 2025 annual report for the Financial Stability Oversight Council…
Administration officials have already moved to overhaul a range of financial regulations this year, including relaxing capital requirements that lenders have said limit their ability to act as intermediaries in the Treasuries market and eliminating post-crisis curbs on leveraged lending.”
December 11 – Bloomberg (Caitlin Reilly):
“The Treasury Department is preparing to release a corporate tax workaround that would deliver large tax savings to companies including Salesforce Inc. and Qualcomm Inc.
The tax guidance, which could come as early as next week, would allow companies to take full advantage of lucrative research and development tax breaks included in President Donald Trump’s ‘One Big Beautiful’ tax bill, according to people familiar…”
Ten-year Treasury yields were up 17 bps in two weeks to the highest yield since September 3rd.
Five-year yields rose Wednesday to an almost four-month high of 3.81% ahead of the FOMC statement.
This yield then fell to a Thursday low of 3.68%, before ending the week back up at 3.74%.
The three-month-to-10-year Treasury spread widened to 56 bps (widest since Sept/Oct ’22 bond instability).
The spread has widened 178 bps since the Fed cut rates in September 2024.
The bond market has reason to gaze around the table and wonder who’s the sucker.
The Fed restarted QE with inflation now deeply embedded.
If speculative Bubbles are sustained, debt markets will have to digest massive AI-related borrowings.
And if Bubbles falter, the administration will employ all available resources to goose the markets and economy ahead of the midterms.
December 9 – Bloomberg (Laura Davison):
“President Donald Trump indicated he would judge a new Federal Reserve chair by whether they immediately move to cut interest rates.
Trump responded ‘yes’ when asked in an interview with Politico if a quick reduction of borrowing costs would be a litmus test for his handpicked central bank leader.
‘Yes. Well, this guy... should too,’ Trump told Politico…, referring to current Fed Chair Jerome Powell.
‘I think he’s a combination of not a smart person and doesn’t like Trump’.”
A pertinent question Friday evening in the Oval Office: “How big a role do you want to personally play in a decision by the Fed on interest rates?”
President Trump:
“Well, you know, I’ve made a lot of money.
I’ve been very successful, and I think my role should be at least out recommending – they don’t have to follow what I say.
But we’re going to be choosing a new Fed person in the pretty near future.
They went out with 71 different people – all economists and Trump.
Of the 71 people, I got it right and one other person – I think from the Wharton School of Finance, my alma mater, got it right. Two people got it right – but I was one of them.
So, I think I should certainly have a role in talking to whoever the head of the Fed is… I
’ve done great.
I’ve made a lot of money - very successful.
I think my voice should be heard.”
December 12 – Wall Street Journal (Meridith McGraw, Nick Timiraos and Brian Schwartz):
“President Trump said he was leaning toward choosing either former Fed governor Kevin Warsh or National Economic Council Director Kevin Hassett to lead the Federal Reserve next year…
During a… meeting with Warsh on Wednesday…, the president pressed Warsh on whether he could trust him to support interest-rate cuts if he were chosen to lead the central bank…
‘He thinks you have to lower interest rates,’ Trump said of Warsh.
‘And so does everybody else that I’ve talked to.
Trump said he thought the next Fed chair should consult with him on where to set interest rates.
‘Typically, that’s not done anymore. It used to be done routinely.
It should be done,’ Trump said. ‘It doesn’t mean—I don’t think he should do exactly what we say.
But certainly we’re—I’m a smart voice and should be listened to.'
Asked where he wants interest rates to be a year from now, Trump said, ‘1% and maybe lower than that.’
He said rate cuts would help the U.S. Treasury reduce the costs of financing $30 trillion in government debt.
‘We should have the lowest rate in the world,’ he said.”
The Trump shtick is really wearing thin.
From Indiana, the House and Senate, the judiciary, grand juries, and even within MAGA, the spectacular Trump power blast has dissipated.
Focused on the Achilles heel of the Trump agenda, Scott Bessent prioritized Treasury market placation.
But bond traders and levered speculators have eyes and ears.
The President presents a major bond market problem, and the unfolding disarray at the Federal Reserve risks a highly destabilizing crisis of confidence.
December 12 – Financial Times (Claire Jones):
“Top Federal Reserve officials have said that the US central bank must not be complacent on fighting inflation, as they warned that long-term borrowing costs will rise if Americans lose faith in policymakers.
Kansas City Fed chief Jeff Schmid… said ‘I continue to hear concerns about inflation’ in his conversations with businesses and households in the US West and Midwest.
‘Inflation remains too high, the economy shows continued momentum, and the labour market — though cooling — remains largely in balance,’ he wrote…
Goolsbee echoed Schmid’s sentiment on inflation, saying on Friday that, ‘given that inflation has been above our target for four and a half years, further progress on it has been stalled for several months, and almost all the businesspeople and consumers we have spoken to in the district lately identify prices as a main concern’.
Another four non-voters launched ‘shadow dissents’, showing on the central bank’s projections that they preferred to keep rates steady rather than the quarter-point reduction…”
For Posterity:
December 12 – Financial Times (Robin Wigglesworth):
“The darkest depths of winter still lie ahead for America’s capital markets: “Earlier this year, the only remaining Democrat commissioner left on the US Securities and Exchange Commission eviscerated the ‘Jenga-like’ dismantlement of the financial regulator.
Yesterday [Caroline Crenshaw] went even further… Her Brookings speech… — titled The Rubble and the Rebuild — still read as a final primal scream at the remarkable evisceration of financial regulation that has happened in 2025.
“It has been unsettling to see how precipitously one Commission is willing to undo the work of the Commission that came before it — all without a single notice-and-comment rulemaking to date.
I’m concerned that the fundamental precepts upon which our markets have been built — tenets that have, by and large, kept our markets safe for both issuers and investors alike — are being eroded.
I fear that the very core of our intricate market structure is under attack.
And instead of safeguarding our markets for investors to fund their retirements in safe and sustainable ways, we are moving in a direction where markets start to look like casinos.
The problem with casinos, of course, is that in the long run the house always wins.”
The appetite to deregulate has been rapacious; the analysis of the costs and benefits of our policies has been non-existent; and, the repercussions, I would argue, could be dire.
We live in an echo chamber where politicians and policymakers make their own truth through repetition.
But, the markets have a way of correcting themselves — not always immediately, but over time.
So, I think the true advisability of these policies will reveal themselves eventually.
I certainly wouldn’t be alone in analogising the trend toward deregulation in the current environment to the period prior to the stock market crash in 1929…
Of late, we have frequently been told that today is a ‘new day’ at the Commission.
But anyone aware of our place in the calendar knows that with each successive day the nights grow longer.
I fear that the darkest depths of winter still lie ahead for America’s capital markets.”
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