The Critical Leap
Doug Nolan
Global de-risking/deleveraging made The Critical Leap from the “periphery” to the “core” – perhaps decisively.
Weaker U.S. economic data, disappointing July Non-Farm Payrolls in particular, will be held more responsible than deserved.
Having gained momentum throughout the week, crisis dynamics only needed a nudge.
A freshly hawkish Bank of Japan surprised markets Wednesday by raising rates and reducing bond purchases.
The yen gained 1.7% Wednesday and was already up 3.2% week-to-date versus the dollar heading into Friday’s weaker employment report – only to jump another 1.7% to end the week 4.93% higher.
The unwind of levered yen “carry trades” gained momentum.
For the week, the Japanese yen significantly added to recent gains against key EM “carry trade” currencies - including the Mexican peso 8.3%, the Colombian peso 7.2%, the Brazilian real 5.9%, Hungarian forint 5.8%, Turkish lira 5.5%, Argentine peso 5.1%, Peruvian sol 4.9%, and Indian rupee 4.7%.
After trading to 161.76 on July 11th, the yen has rallied 10.35% to 146.53 to the dollar.
Over this period, the Mexican peso is down 15.7% versus the yen, the Brazilian real 14.3%, the Chilean peso 13.1%, the Colombian peso 12.9%, the Argentine peso 10.8%, the Turkish lira 10.4%, the South African rand 10.1%, the Hungarian forint 9.6% and the Indian rupee 9.6%.
Huge leveraged speculating community “carry trade” losses continue to mount.
It’s easily lost in a dizzying week that U.S. markets rallied strongly Wednesday on a “dovish hold” FOMC meeting.
“Stocks Storm Back on Fed Day as Nvidia Surges 13%.”
The Semiconductor Index rallied 7.0%, the Nasdaq100 3.0%, and the S&P500 1.6%.
It quickly became an unforgiving head fake, ruthlessly punishing the over-confident buy-the-dip crowd.
The Semiconductors reversed 7% lower on Thursday, with the Nasdaq100 down 2.4%.
Nvidia sank 6.7% Thursday, with Micron down 7.6% (and another 8% in evening trading).
Amazon.com was also down post-earnings Thursday evening, with Intel crushed 20%.
Thursday’s failed tech rally sparked risk aversion, with the AI Bubble mania in serious trouble.
Interestingly, investment-grade spreads (to Treasuries) widened five to 98 bps – the largest daily risk premium increase back to banking crisis March 13th, 2023.
High yield spreads widened 11 Thursday to 325 bps – the largest move in six months.
Bank CDS also came to life Thursday – at home and abroad.
European subordinated bank debt CDS jumped eight Thursday (to 120bps), the largest daily gain since June’s French election earthquake.
Bank of America CDS jumped four (to 56bps) and Citigroup three (55bps) – both the largest one-day gains since October 2023 (Israel/Hamas war).
The KBW Bank Index was slammed for 3.0% in Thursday trading, with Europe’s STOXX 600 Bank Index sinking 4.5%.
EM CDS rose five (174bps) Thursday, as the Brazilian real declined another 2.1% against the yen, the Mexican peso 1.7%, and the Chilean peso 1.6%.
Sniffing out trouble, two-year Treasury yields sank another 11 bps - following Wednesday’s 10 bps decline - to a 14-month low of 4.15%.
Quickly gathering momentum, global de-risking/deleveraging was at the cusp of triggering disorderly Treasury market (“core”) trading – a market these days dominated by levered speculation and derivatives hedging strategies.
Friday, 8:30 am Eastern: 114,000 payrolls added in July, down from June’s revised lower 179,000, and badly missing the consensus estimate of 175,000.
Worse yet, the Unemployment Rate unexpectedly rose two-tenths to 4.3%, while Average Hourly Earnings missed by a tenth at 0.2% (3.6% y-o-y).
Disorder, coiled and ready, unleashed.
Markets quickly began to dislocate.
Ten-year Treasury ended the session 19 bps lower at 3.79% - with yields down a stunning 40 bps for the week.
Two-year Treasury yields dropped 27 Friday and 50 bps for the week – the largest weekly yield collapse since the March 2023 banking crisis.
August 2 – Bloomberg (Catarina Saraiva and Ananya Chag):
“Federal Reserve Bank of Chicago President Austan Goolsbee emphasized the central bank will not overreact to any one report, adding policymakers will get a lot of data prior to the Fed’s next meeting.
Goolsbee… said it’s the Fed’s job to figure out the ‘through line’ of the data and move in a ‘steady’ way.
Still, he noted if rates stay restrictive too long, policymakers have to think about the employment side of the mandate.
‘We’d never want to overreact to any one month’s numbers,’ Goolsbee said…
But ‘if unemployment is going to go up higher than the neutral rate, that is exactly the kind of pinching on the other side of the mandate that the law says the Fed has to think about and respond to.’”
August 2 – Bloomberg (Craig Torres):
“Federal Reserve Bank of Richmond President Thomas Barkin said the US economy is in good shape, though it’s unclear whether the labor market is getting back to normal rates of hiring or more seriously deteriorating…
‘We’ve been through two years, two-and-a-half years of very frothy labor markets,’ Barkin said…
‘The question is, of course, are we normalizing or are we weakening?’
The difference is meaningful, he said, adding, ‘It gets to the question of whether we’re going to plateau or whether unemployment’s going to rise from here.’”
August 2 – Bloomberg (Ye Xie):
“Wall Street banks are calling for aggressive interest-rate cuts by the Federal Reserve based on the latest evidence that the labor market is cooling.
Economists at Bank of America..., Barclays Plc, Citigroup Inc., Goldman Sachs… and JPMorgan… revamped their forecasts for US monetary policy Friday after data showed the US unemployment rate rose again in July.
All are calling for earlier, bigger or more interest-rate cuts. Citigroup economists said they expect half-point rate cuts in September and November and a quarter-point cut in December…
JPMorgan economist Michael Feroli went a step further.
While he also predicted half-point rate cuts in September and November, followed by quarter-point reductions at every subsequent meeting, Feroli said there’s ‘a strong case to act’ before the next meeting on Sept. 18.”
“…The Beige Book is great.
What’s even greater is hearing the Reserve Bank presidents come in and talk about their conversations with businesses, and business leaders and workers, and people in the nonprofit sector in their districts.
But I’ll tell you, it’s a pretty, the picture is not one of a slowing or a really bad economy, it’s one of there are spots of weakness and there are regions where growth is stronger than other regions, but overall, it’s again, look at the aggregate data.
Aggregate data is, particularly… Private Domestic Final Purchases, is 2.6% and that’s a good indicator of private demand.”
- Chair Powell, July 31, 2024
Having read the FOMC statement and listened carefully to Chair Powell’s press conference, there was nothing indicating sensitivity to unfolding de-risking/deleveraging.
Any suggestion at Wednesday’s FOMC meeting of two 50 bps cuts by year-end would surely have been met with chuckles and sneers.
While some data suggest an unfolding slowdown, the notion of an economy currently falling off a cliff is not credible.
But that doesn’t mean I dismiss the calls for aggressive rate cuts from BofA, Barclays, Goldman, and JPMorgan.
They are, after all, in the catbird’s seat monitoring de-risking/deleveraging – a dynamic that this week turned serious.
And a serious market deleveraging would certainly awaken the Fed into action – rate cuts and, I would not be surprised, an abrupt expansion of the Fed’s balance sheet.
Recall the March 2023 banking crisis provoked a $700 billion Fed/FHLB liquidity response.
“The Fed is behind the curve.”
“Federal Reserve Under Fire as Slowing Jobs Market Fans Fears of Recession.”
“Warren Tells Fed Chair Powell to 'Cancel His Summer Vacation' and Cut Rates Now.”
And there’s a chorus of “I told you so” from those that have been pushing rate cuts.
Yet, the crucial issue is neither a cooling labor market nor a weakening economy.
We’re staring at what could prove the start of downfalls for the greatest Bubbles in human history.
I began the December 15th CBB, “Guard Down, Towel Tossed” with, “History will be the judge.
This period will be examined, analyzed, discussed, and debated for at least the next century.”
Powell succumbed, he pivoted dovish at the December 13th FOMC meeting and press conference.
Between that fateful Fed meeting and July 10th peak highs, the Semiconductors inflated 50%.
Nvidia ballooned 183% to surpass $3 TN in market cap.
The Nasdaq returned 27% and the S&P500 22%.
The Fed pivoted despite loose market financial conditions and historic speculative excess.
We can assume seven months of enormous growth in leverage throughout equities and related derivatives, especially in big tech.
I suspect speculative leverage also expanded aggressively in “carry trades,” “basis trades,” and throughout corporate Credit – at home and globally.
A true debacle of perilous speculation.
The Fed and Bank of Japan needed to have been mindful that Bubbles typically conclude with destabilizing speculative blow-offs.
They failed to tighten sufficiently to thwart perilous asset inflation and market melt-ups.
There was no recognition of the great systemic damage inflicted during “Terminal Phase Excess.”
The unfolding crisis will be deeper and more painful due to seven additional months of crazy late-cycle excess – not because the Fed was slow to cut rates.
Inflated markets and unbalanced maladjusted economies are today only more vulnerable to de-risking/deleveraging and an associated abrupt tightening of financial conditions.
True, markets have repeatedly recovered from incipient de-risking. Friday looked different.
Investment-grade CDS jumped 3.7 to 58.3 bps in Friday trading, the largest one-day gain since September 20, 2023 (Powell’s not well-received higher for longer press conference).
High yield CDS posted the largest one-day (22bps), two-day (39bps), and one-week (38bps) gains since the March 2023 banking crisis.
For the week, investment-grade spreads (to Treasuries) widened 12 to 105 bps - the largest weekly increase since the week of March 17, 2023.
High yield spreads surged 53 bps this week – the largest gain since the March ’23 banking crisis’ 59 bps spike.
Citigroup and Bank of America CDS posted their largest daily and weekly gains since October.
The KBW Bank Index sank 7.8% this week, with the Broker/Dealers falling 6.8%.
MBS yields dropped 29 bps Friday, the largest one-day decline since December 13th, 2023.
The 51 bps decline for the week was the most since November, 2022.
Importantly, the unfolding crisis is global.
Europe’s STOXX Bank Index sank 7.8% this week, with Italian bank stocks down 8.6%.
Japan’s TOPIX Bank Index dropped 6.8%.
UK 10-year yields dropped 27 bps, and German bund yields fell 23 bps to a six-month low of 2.17%.
European periphery bond risk premiums rose. Italian yield spreads to German bunds widened 10, Greece nine, and France eight bps (to 80bps).
European subordinated bank debt CDS jumped 18 bps, second only to June’s 32 bps French election surge for data back to the March 2023 U.S. banking crisis.
European high yield CDS jumped 37 to 332 bps.
EM CDS jumped 16 to 183 bps – the largest weekly gain since August 2023 – to the high since April.
The market closed Friday pricing a 4.14% year-end Fed policy rate (implying 119bps of rate cuts), down an extraordinary 36 bps for the day and 50 bps for the week.
The one-year overnight swaps rate sank 49 bps this week to 4.255% – the largest weekly decline since March 2023.
Friday’s 29 bps collapse was the biggest single-session decline since March 17th, 2023.
The unfolding de-risking/deleveraging will pose a greater challenge for the Fed than the March 2023 bank liquidity crunch.
New bank liquidity facilities will not ameliorate cross-market and global speculative deleveraging.
And recalling the March 2020 experience (panic hedge fund deleveraging), it required the Fed to massively ratch up QE announcements to begin quelling the liquidations.
I don’t expect the Fed to be quick to open the QE floodgates.
And we’re now 94 days from what will be an incredibly contentious - and likely close - election.
For what has already been inconceivable political drama, a market crisis somehow seems fitting.
And the Fed thinks it can stay out of the political fray.
Meanwhile, Iran and Hezbollah plot revenge attacks against Israel – with the U.S. moving additional military firepower to the region.
Manias are incredibly adept at fixating, obsessing, and imagining, all the while disregarding myriad risks.
But it always comes back to bite.
This is going to bite real hard.
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