Rapscallions Crowding Out
Doug Nolan
Folks in the future will undoubtedly find this period confounding.
It’s a fundamental Credit Bubble principle that things get crazy at the end of cycles.
Super cycles ensure Super Crazy.
And there’s the theme for 2026 in play: “Expect the Unbelievable.”
Maybe the war is ending soon.
And, then again, maybe it’s not.
Either way, it is a reasonable assumption that normality returning to the Gulf will be a begrudgingly rocky process.
December 2027 crude futures closed the week at $72.40, up 25% from the start of the year.
While retreating 1.3% this week, the Goldman Sachs Commodity Index has gained 26.2% y-t-d.
The S&P500 has now rallied 17% from March 30th lows, a relatively feeble rally compared to melt-up dynamics, which have taken hold in key indices and markets.
That Nasdaq100 has surged almost 28% from March lows, while the MAG7 has jumped 27%.
The Semiconductors’ 66% melt-up rally places 2026 gains at a blistering 65%.
While lagging tech, the small cap Russell 2000’s 20% rally pushed y-t-d gains to 15.2%.
The Goldman Sachs most short index rallied as much as 31%, with 2026 gains ending the week at 26.3%.
Gulf and energy market instability is a major risk throughout Asia.
No worries.
Apparently, no risk matters much so long as the AI arms race continues unimpeded.
South Korea’s (semiconductor and tech heavy) KOSPI Index has rallied 49% from March 30th lows.
The KOSPI surged 13.6% this week, inflating y-t-d gains to 77.9%.
But that’s less than five months.
The KOSPI boasts a one-year return of 195%.
The Taiwan TWSE Index’s 6.9% gain pushed 2026 returns to 44.0%.
In China, the CSI 300 IT and ChiNext indices enjoyed weekly gains of 7.2% and 5.5%.
Money Market Fund Assets (MMFA) surged $122 billion last week, the largest weekly gain since December 3rd ($132bn – the biggest increase since Covid April 2020).
Conventional analysis has traditionally associated rapid growth in money fund assets with equities market risk aversion.
An analytical framework overhaul is long overdue.
Not coincidently, the early December MMFA surge also occurred in a “risk on” squeeze environment.
November had been a dicey period for equities, especially in the tech sector.
From November 3rd highs to November 21st lows, the Semiconductor and MAG7 indexes reversed 16% and 9% lower.
Market concerns were alleviated by a strong forecast from Nvidia.
A sharp market reversal saw the VIX drop from a November 20th high of 28.27 to a November 28th 15.78 close.
A peppy short squeeze erupted, with the Goldman Sachs Most Short Index surging 18.6% from November 21st lows to the November 28th close.
The abrupt return of “risk on” saw high yield CDS reverse sharply lower - from 353 to 322 bps.
Curiously, the bond volatility MOVE Index sank from 84.3 on the 19th to a November 28th close of 68.95.
Strong moves in dollar swap spreads also suggested a sharp uptick in leveraged speculation.
With roots back to classical economists such as David Ricardo and John Stuart Mill, “crowding out” theorizing enjoyed its heyday during the eighties and the Reagan big deficit spending era.
It only seems reasonable that excessive government borrowing and spending would come at the expense of private sector investment and activity.
Well, deficit spending will (again) approach $2 TN this year.
However, these days no one (other than perhaps Apollo’s Torsten Sløk) has a care in the world that massive government borrowing could impede the multi-trillion AI buildout.
The complete breakdown of the relationship between borrowing demands and the price of finance is fundamental to Credit Bubble analysis.
After all, functioning market pricing and adjustment mechanisms are essential for Credit and monetary stability.
At least traditionally, rising financing costs helped cool overheated borrowing.
This market dynamic is indispensable to sound capitalistic systems, both from financial and economic stability perspectives.
Long time in the making, the breakdown of the relationship between borrowing demands and the price of finance accelerated in the nineties.
The rapid expansion of non-bank finance was key, most notably the proliferation of leveraged speculation and concurrent rapid expansion of “repo” finance, money market fund intermediation, and the GSEs.
In a historic yet unappreciated development, the supply of available finance essentially became unlimited.
It’s nothing short of late-super cycle crazy.
Unbelievable, and only more unbelievable that it unfolds with nary a peep from Fed officials or the economic community.
In a number I tabulate weekly, MMFA have inflated $3.165 TN, or 69%, since the week of October 26, 2022.
This historic monetary inflation has corresponded with an extraordinary ($3TN plus) expansion of “repo” finance and hedge fund leveraged speculation.
Many important things were thrown out the window when the Fed and global central bank community adopted QE – especially the open-ended “whatever it takes” variety.
With the Fed ready to aggressively buy (monetize) Treasuries to quash any nascent bout of (much needed) market adjustment, this extraordinary market liquidity backstop incentivized the leveraged speculating community’s accumulation of highly levered Treasury holdings.
This effectively quashed any hope that market discipline would impose some fiscal restraint on Washington.
And you can’t overstate the monumental significance of this financial and policy evolution.
Persistent massive federal deficit spending promotes ongoing economic expansion and a semblance of stability and resilience.
Even the massive $6 TN two-year Covid deficits were financed at the most marginal interest rates.
There is seemingly no crisis not resolvable through the trifecta of deficit spending, Fed monetization, and hedge fund leveraging.
Moreover, the greater the degree of Bubble excess, the more confidence the leveraged speculating community gains in fiscal and monetary policy backstops.
We’ve reached the point in the speculative cycle where massive fiscal deficits only stoke general excess.
Paradoxically, extreme borrowing demands foster loose conditions, as hedge funds and others finance levered Treasury (and other) holdings in the “repo” marketplace (intermediated through the money fund complex).
Two key dynamics sustain general Bubble excess.
First, massive deficit spending supports incomes, spending, corporate profits, and asset prices.
Second, extraordinary liquidity expansion sustains loose financial conditions, household and corporate borrowings, financial speculation and leveraging, and inflated market Bubbles generally.
Importantly, similar “global government finance Bubble” dynamics flourish around the globe, promoting historically unique loose financial conditions internationally.
What could upset the applecart?
May 5 – Axios (Madison Mills):
“The biggest tech companies are set to spend $1 trillion on AI by next year…, a bill so big that it’s propping up both the stock market and economy.
Our financial system is now load-bearing on AI spending that may never pay off, and most investors can't even see what the full tab is.
The biggest tech firms are on track to spend $700 billion on their AI ambitions this year, double their 2025 spending, according to Goldman Sachs.
That could swell to over $1 trillion next year…
AI costs went up, not down, for four of the Big Tech companies that reported earnings last week, according to Bank of America.
As their cash flows erode, these companies argue they have to keep spending to stay ahead in the AI race.”
Even with the week’s 6.4% retreat in crude prices, 10-year Treasury yields only mustered a two bps decline (to 4.35%).
Two-year yields added a basis point to 3.88% - having surged 50 bps since the February 27th close.
Overheating risks are high and rising.
April Non-Farm Payrolls were reported at a stronger-than-expected 115k, with a 123k gain in Private Payrolls (March revised 8k higher to 185k).
The Unemployment Rate was unchanged at 4.3%.
ADP reported April job gains of 109k, up from March’s 61k.
Job Openings (JOLTS) of 6.866 million remain elevated on a historical basis.
At 200k, weekly unemployment claims continue to signal labor market firmness.
And after four months of the year, Challenger job cuts are 10% below comparable 2025.
One of my favorite economic indicators, the ISM Services Index, slipped marginally in April to a still robust 53.6, with 14 industries reporting expansion versus only three in contraction.
The ISM Services Prices Paid component was unchanged at 70.7, matching the high back to October 2022.
At 3.64%, New York Fed Inflation Expectations was reported at the highest level since September 2023.
Surely boosted by high gas prices, Consumer Credit popped in April to $24.9 billion (est. $13.7bn), the strongest gain since November 2022.
Stronger-than-expected: March Factory Orders (up 1.5% vs. 0.6% forecast) and March New Home Sales (682k vs. 652k).
After trading up to 335 bps to end March, high yield spreads are back down to 266 bps – below the February 27th pre-war level (291bps) and unchanged from the start of the year.
At 77 bps, investment-grade spreads are also below pre-war levels.
The VIX and MOVE volatility indices have both retreated to pre-war levels. In short, financial conditions have loosened meaningfully.
At this point, it’s only a matter of how much of an inflationary spike is in the offing.
Much depends on how long traffic through the Strait of Hormuz remains impeded.
This creates an especially precarious backdrop for loose conditions, market speculative melt-ups, and general overheating.
Throw in massive deficit spending (for as far as the eye can see), and this is clearly a risky juncture for highly levered U.S. and global bond markets.
What’s more, there’s rapidly escalating borrowing requirements to finance the historic AI arms race.
Cracks are developing in global bond land.
May 5 – Bloomberg (James Hirai and Georgia Hall):
“UK long-term borrowing costs jumped to a 28-year high as worries intensified over local government elections and the impact of soaring energy prices on the economy.
The yield on 30-year gilts surged as much as 13 bps to 5.78%, the highest since 1998.
The selloff swept across bonds of all maturities, with 10-year notes topping 5.10%...
While bond investors around the world have signaled their discontent with faster inflation and potentially higher interest rates, the UK stands out as the most extreme example.
The combination of Britain’s messy political landscape, with unpopular Prime Minister Keir Starmer likely to face a leadership challenge, feeble economy and strained government finances have made it a target for traders looking for a weak link.”
May 7 – Financial Times (Ryan McMorrow, Rafe Rosner-Uddin, Stephen Morris and Hannah Murphy):
“Big Tech’s record $725bn AI investment strategy is beginning to strain the resources of America’s largest companies, leaving them with less cash left over this year than at any point in the past decade.
The combined free cash flow of the four ‘hyperscalers’ — Amazon, Alphabet, Microsoft and Meta — is expected to fall to roughly $4bn in the third quarter, according to Wall Street’s forecasts, down from an average of $45bn in each quarter since the Covid-19 pandemic six years ago.
Their full-year free cash flow is set to hit the lowest level since 2014, when their revenues were about a seventh of their current size, according to analysts’ estimates compiled by Visible Alpha.
It is a striking turn for companies that have rapidly transformed from relatively asset-light cash generators into some of the world’s biggest investors in physical infrastructure.”
May 6 – Reuters (Karin Strohecker):
“Investors are showing signs of diversifying away from U.S. Treasuries as global debt levels hit a record of nearly $353 trillion by end-March, a report by the Institute of International Finance… found.
IIF’s quarterly Global Debt Monitor said that strengthening international demand for Japanese and European government bonds contrasted with broadly stable demand for U.S. Treasuries since the start of the year.
‘This highlights that there are some efforts by international investors diversifying away from U.S. Treasuries,’ Emre Tiftik, director at the IIF for Global Markets and Policy said…
Washington’s borrowing push was one of the main drivers for global debt to rise by over $4.4 trillion in the first quarter, the fastest increase since mid‑2025 and the fifth straight quarterly increase...
Tiftik said the rise in U.S. debt had been largely driven by government borrowing.”
And let’s not forget the festering private Credit and high-risk lending problem.
May 6 – Bloomberg (Silla Brush):
“DoubleLine Capital Chief Executive Officer Jeffrey Gundlach raised pointed questions about financial advisers and other intermediaries who ushered individual investors into private credit and other so-called semi-liquid funds, suggesting they’ve been motivated by high fees as much as by their clients’ interests.
‘It’s clear that prospectuses talked about the gating mechanism, but I have a feeling that the financial intermediaries, not all of them of course, but enough of them, didn’t explain,’ he said…
The products have been ‘kept opaque and not granularly described,’ he said.
‘That’s why everybody wants their money back: They’re starting to realize they might be the bag-holder.’
Gundlach took issue specifically with private credit firms calling their funds ‘semi-liquid’ in nature.
‘Semi-liquid is kind of a diabolical name,’ Gundlach said.
‘Half the time it’s liquid.
It’s liquid when you don’t want your money, and it’s illiquid when you do want your money.’”
Jeffrey Gundlach provided an extensive interview Thursday afternoon on Bloomberg Television, where he offered an interesting take on private Credit, while comparing it to 2007 and the subprime mortgage debacle.
Gundlach:
“I’ve used the analogy of the wild west.
This is what I think really explains it in simple terms.
You have this nice town – it’s 1840.
Out on the frontier, you have this little town.
Mostly farmers living off the land.
And they’re all God-fearing people.
There’s a sheriff there who has a heart of gold.
He’s like Gary Cooper in High Noon.
And there’s little crime.
Every now and then there’ll be a murder of passion.
No one even locks their doors.
You don’t have to worry about it.
But then something happens.
There’s a discovery of gold three miles away.
And all the sudden all the fast-buck artists, the con men, rapscallions – they come flooding in.
Not everybody is a rapscallion.
But a sufficient fraction of them are rapscallions.
And they’re coming in there to hit it big and then get out.
Suddenly there’s murders – you have to lock your door.
You have to barricade your door.
The sheriff is completely overwhelmed.”
Bloomberg’s Romaine Bostick:
“Who’s going to clean it up this time?
Who's going to be the Gary Cooper?”
Gundlach:
“The market will be the Gary Cooper.
The market inflicts the pain…”
Gundlach also spoke cautiously on the Treasury market, suggesting possible draconian measures that might be necessary as deficits spiral out of control.
Years of excessively loose conditions and government backstops ensured high-risk lending market infestation with fast-buck artists, con men, and rapscallions.
I ponder how much leverage the rapscallions accumulated; in what markets; and to what degree, over many Bubble years, they crowded out the prudent and responsible.
We can only hope easy-money rapscallion proliferation has not been as systemic as I suspect.
0 comments:
Publicar un comentario