Bubbles, Dams, War and Cracks
Doug Nolan
Global markets are at the precipice.
Nerves are increasingly frayed, yet complacency remains well entrenched.
This is not uncharted territory.
De-risking/deleveraging approaches critical momentum, before some policy response swiftly turns things around.
The “Fed put,” the “TACO put,” the global policymaker “put”…
When speculative deleveraging momentum gathered pace in the summer of 2019, the Federal Reserve restarted QE.
When autumn 2022 UK gilt deleveraging sparked global bond deleveraging, the Bank of England postponed QT and intervened with aggressive gilt purchases (QE) and a temporary liquidity facility.
As the March 2023 SVB/bank crisis spurred fear and deleveraging, the Federal Reserve and Federal Home Loan Banks responded urgently with $500 billion of liquidity injections.
During the August 2024 yen “carry trade” unwind (Nikkei plunged 12.4% on August 5th), the forces of de-risking/deleveraging were abruptly reversed by BOJ Governor Shinichi Uchida’s reassuring comments (BOJ won’t raise rates when markets are unstable).
And when markets were at the cusp of unraveling during “liberation day” April 2025 instability, the “TACO put” (tariff pause) unleashed a major short squeeze, unwind of hedges, liquidity surge, and blow-off excess for the ages (i.e., AI arms race, “private Credit” lending finale, crypto blowoff, and caution thrown to the wind across global asset markets).
The current backdrop is unique.
The IRGC currently retains the capacity to essentially shut the Strait of Hormuz.
Iranian missiles and drones could potentially destroy major Middle East oil production and refining capacity.
After three weeks, it’s anything but clear when bombings and assassinations will neutralize the IRGC ability to hold the world’s markets and economy hostage.
Risks to global markets, finance, and economies are the most extreme in decades.
With inflation risk pummeling global bond markets, now typical central bank QE responses would come with atypical issues and challenges.
At the minimum, I would expect central bank liquidity responses to be more cautious – slower and smaller in scope than markets will demand.
As for the “TACO put,” it faces the Laws of Diminishing Efficacy.
The President does not control war developments.
Some 1,200 CBBs ago, I titled the March 31, 2000, commentary “A Derivative Story.”
“Imagine a quaint and tranquil town near a pristine river.
Throughout history, this river has been prone to the occasional dangerous flood that would completely wipe out the unfortunate homeowners within the flood zone.
Demonstrating the prudence that comes from an appreciation of history, few individuals were willing to take the high risk of gambling with Mother Nature.
But after several floodless years, and perhaps persuaded by stagnant profits in the property and casualty insurance business, the local insurance company… begins offering limited flood insurance…”
In my tale of woe, ongoing drought and booming flood insurance profits enticed other insurers, some increasingly eager to write policies right along the riverbank.
Riverside building boomed, right along with insurance “profits.”
It didn’t take long for others to take a piece of the action, with financial speculators posing as insurance operators.
The long drought solidified the notion that insurance premiums were essentially profits.
And as speculators came to dominate the marketplace, few “insurers” even bothered to hold reserves against future loss claims.
A vibrant reinsurance market developed, a highly liquid marketplace that allows “insurers” to easily offload policies.
Many planned that, in the unlikely event of heavy rain, they would simply purchase inexpensive reinsurance.
Unprecedented construction fueled community prosperity like never before, as euphoria and manic excess enveloped insurance and reinsurance markets.
Somehow, the Bubble and associated fragility went unrecognized.
The few old-timers that vividly recalled past flood devastation eventually just kept their traps shut.
Only losers weren’t making it bigtime.
“I will conclude this chapter (March 2000) of a derivative story with news of an ominous climate change recognized by only the most astute and sophisticated traders in the flood insurance marketplace.
As the savvy ‘in the know’ players begin to unwind positions, strange happenings overwhelm the insurance market…
Most unfortunately, the flood insurance and reinsurance markets have regressed to little more than a game of musical chairs.
When the music finally stops, there will be scant true capital or wherewithal available to satisfy the insurance obligations created in the marketplace.
One thing for sure, after years of excessive risk taking and an endemic misallocation of resources, risks have grown exponentially.
A flood that not many years before would have caused relatively moderate damage now holds undeniable potential for catastrophe.”
Over the years, I’ve on occasion updated the “little town on the river” fable.
It took only one major torrential rainstorm to unleash bloody mayhem throughout the reinsurance marketplace.
With very few planning to actually function in the insurance business, heavy rain triggered most players to move simultaneously to offload their insurance obligations.
There were no takers.
The market collapsed in illiquidity.
But rather than a sad ending of a life of hard knocks and lessons learned, the story’s fateful plot was just unfolding.
Local government and community bank officials moved forcefully to bail out the collapsing insurance market.
This ensured that a steady stream of new policies, an ongoing building boom, and ever rising real estate prices were soon back on track.
Importantly, a new dam was constructed upriver.
This essentially removed any fear of catastrophic flooding, a Godsend for the bubbling reinsurance marketplace.
Sometime later, when a protracted rainy period saw the flooding river cascade over the dam crest, another insurance market panic struck the community.
Local officials moved further up the river with another dam project.
When the new reservoir filled to its brim, the community was again at the cusp of major crisis.
Seasoned officials were ready with a plan for yet another dam – and more for the future as necessary.
The community boomed like never before.
Some were disheartened to see the beautiful old riverbank homes demolished to make room for fancy casinos - beloved local businesses replaced by luxury shops and auto dealerships, real estate agents and financial advisors.
Most felt heightened insecurity, as incomes failed to keep up with surging living costs and home prices.
Over time, envy festered into animosity.
I don’t recall the timing of my last “little town…” update.
The Iran War compels me.
There’s been an earthquake.
It’s not the “big one,” but it was enough to cause cracks in one of the upriver dams.
The shaking has somewhat rattled the community, but any rise in the river level has gone unnoticed.
Word of cracks has not yet leaked out, with only the most knowledgeable contemplating the integrity of the dam system.
The more prudent and savvy insurance operators are moving to de-risk flood exposure, while the usual crowd of players conditioned to add policies on every price hike are keen to again take full advantage of windfall profit opportunities.
Basically, the community is unaware of myriad risks – numbed from decades of repeating bouts of torrential rain, brief flooding, bailouts, whatever it takes dam construction, and greater prosperity.
The fact of the matter is that the dam system was constructed with subpar geotechnical engineering and a lack of rigorous study and planning.
Truth be told, the reservoirs and dam projects fall along a seismic hazard zone.
While they don’t occur often, there is a well-documented earthquake recurrence cycle.
It’s when and not if.
The fault line is vulnerable, and a major quake is long overdue.
Nevertheless, it’s business as usual for most of the community.
The quake is not a serious issue.
Ramifications are easily dismissed.
After all, the epicenter was some distance away.
Ominously, there’s that barely noticeable crack in the structure of the upriver dam.
Might it presage uncontrolled water leakage, internal erosion, and catastrophic failure?
What would dam collapse mean for the entire reservoir and dam system?
And how about the likelihood reverberations from the distance quake triggered fragility along the local fault line?
The multi-decade development from little town to booming metropolis all along the river has been nothing short of phenomenal.
March 19 - Bloomberg (Natalia Kniazhevich):
“Wall Street equities traders are bracing for an unusually large tally of options expiring on Friday, which risks injecting even more volatility into a market that’s seen weeks of turbulence amid the raging Mideast conflict.
Roughly $5.7 trillion in notional options tied to individual US stocks, indexes and exchange-traded funds are set to expire on Friday in the quarterly event that traders have dubbed the ‘triple-witching’ — the largest March expiry in Citigroup Inc. data going back to 1996.
That figure includes $4.1 trillion in index contracts, $772 billion in exchange-traded funds and $875 billion in single-stock options.”
It was a close call, but the largest ever Q1 options/derivatives expiration went off without an accident.
That said, it was anything but pretty.
Friday saw a troubling market dynamic in full force.
No place to hide.
No safe havens.
Key “insurance” (Credit default swaps) markets lurching toward dislocation.
Global bonds under further heavy selling pressure.
Treasuries, MBS, agencies, corporates, and muni bonds all hammered.
Stocks clobbered.
Precious metals battered.
Spreads blowing out.
CDS prices spiking higher.
Emerging markets bludgeoned.
Currency instability taking hold.
In short, de-risking/deleveraging intensified.
“Risk parity,” “basis trades,” “carry trades”, and myriad levered strategies experienced mounting losses.
In short, the leveraged speculating community is on their heels and losing balance.
The popular levered European bond trade is blowing up.
Ten-year UK Gilt yields surged 15 bps Friday, trading above 5.0% for the first time since 2008.
Gilt yields have spiked 76 bps since the start of the war.
Italian yields jumped 19 bps Friday (up 69bps in three weeks) to 3.96%, near the high back to December 2023.
Friday trading saw Greek yields rise 17 bps to 3.93% (up 68 bps in three weeks), the high back to November 2023.
Bond losses were certainly not limited to Europe.
Australian 10-year yields rose 13 bps Friday to a 15-year high 5.02%, with New Zealand yields up 14 bps to 4.72%, near a more than two-year high.
Reflective of intensifying stress on popular (crowded) levered “carry trades”, EM bonds (local currency and $) were under pressure.
Friday dollar bond yield gains included Argentina’s 25 bps (10.53%), Ukraine’s 18 bps (15.27%), Turkey’s 16 bps (7.53%), Mexico’s 16 bps (6.10%), Peru’s 15 bps (5.50%), Brazil’s 15 bps (6.35%), and Chile’s 14 bps (5.07%).
Friday’s local currency bond yield jumps included Brazil’s 20 bps (14.18%), Cyprus's 19 bps (3.61%), Hungary’s 15 bps (7.34%), Chile’s 13 bps (5.77%), and South Africa’s 12 bps (9.28%).
Friday EM currency losses included Chile (2.1%), Brazil (1.8%), South Africa (1.6%) and India (1.1%).
Pressured by mounting bank and financial stress, India’s rupee is down 4.1% y-t-d to a record low versus the dollar.
Quarterly CDS contract roll (to a later maturity) was somewhat of a factor, yet Friday’s 52 bps spike in EM CDS (to high since April) was extraordinary.
US high yield CDS jumped 17 bps Friday to 375 bps, the high back to May.
Investment-grade CDS jumped eight to 66 bps (high since April).
Morgan Stanley, Goldman Sachs, Bank of America, Wells Fargo, and JPMorgan CDS all jumped to April/May highs.
European (subordinated) Bank CDS spiked 16 bps Friday (3-wk gain 32bps) to 133 bps (high since April).
The MOVE (bond market volatility) Index spiked an extraordinary 24 Friday to 109 – the high since April, almost double the largest daily “liberation day” move.
The MOVE index was at 64 bps prior to the war.
MBS yields surged 20 bps in Friday trading to 5.47%, with a three-week spike of 66 bps.
It was the largest daily yield spike since April 7th (21bps).
Friday action saw 10-year Treasury yields jump 13 bps to an eight-month high of 4.38% (up 44bps in 3 weeks).
Friday’s 11 bps jump boosted the week’s two-year yield spike to 18 bps - to 3.90% (high since July), with a three-week surge of 53 bps.
“Muni Market Rout Deepens as Iran War Stocks Inflation Concerns.”
Friday saw an alarming rout throughout global bonds and U.S. fixed income.
It is not a sustainable dynamic for such highly levered markets.
Friday evening from Bloomberg (Jeff Mason and Courtney Subramanian):
“President Donald Trump said he was considering ‘winding down’ US military efforts against Iran, saying that the US was close to achieving its objectives as the conflict, which has roiled financial markets and the region, nears a fourth week.
‘We are getting very close to meeting our objectives as we consider winding down our great Military efforts in the Middle East,’ Trump said in a social-media post...
He cast those objectives as ‘Completely degrading’ Iran’s missile capabilities, ‘destroying’ the country’s defense industrial base, eliminating their navy and air force, never allowing Tehran to get close to a ‘Nuclear Capability’ and protecting Middle Eastern allies.”
On the one hand, the President’s about face is consistent with how he’s previously responded to acute market instability.
On the other hand, “winding down” is completely incongruent with recent messaging and reports of additional US Marine Corp deployments to the Middle East.
Trump continued with his confounding post:
“The Hormuz Strait will have to be guarded and policed, as necessary, by other Nations who use it — The United States does not!
If asked, we will help these Countries in their Hormuz efforts, but it shouldn’t be necessary once Iran’s threat is eradicated.
Importantly, it will be an easy Military Operation for them.”
Abandoning efforts to open the Strait of Hormuz would at this point throw Colin Powell’s “You break it, you own it” completely on its head.
Already fraught relations with “allies” would surely sink to new lows.
It’s difficult to imagine U.S. and Israeli bombing operations easing anytime soon.
And so long as the attacks and assassinations continue, Iran will maintain its pressure point on Gulf tanker traffic.
Despite incredible U.S./Israeli military success, the IRGC demonstrated this week that they retain the capacity to throw world energy markets into complete chaos.
“Expect the unbelievable” is a CBB theme for 2026.
Well, this is an unbelievable mess.
I wouldn’t bet on global financial markets having weeks to sort through it all.
And the midterms loom.
The President has extremely difficult decisions to make.
It’s hard to believe the hard-line Iranian regime will be allowed to regroup, rebuild and rearm – with a new missile arsenal surely pointed directly at the Strait of Hormuz and Gulf energy infrastructure.
But efforts to bomb and strangle the regime into submission seem certain to at some point elicit scorched earth mayhem throughout the Gulf.
Market stability and the global economy today hang in the balance.
It’s not easy to envisage a more uncertain environment.
Global finance is in the initial phase of what I expect to be a protracted and challenging deleveraging period.
Short squeeze and hedge unwind rallies will add to instability.
And with our nation at war and critical midterms only months away, strange market trading dynamics would not be surprising.
But there are now identifiable cracks.
Dams could start giving way at any time.
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