Cycle Transition
Doug Nolan
Global markets have become a minefield, an especially precarious circumstance, considering the unprecedented scope of leverage and speculative excess.
It was supposed to be a positive recovery week leading up to the midterms.
The excitement of an Anthropic IPO announcement.
Big tech, with key earnings reports and investor days, would surely bolster confidence in the sustainability of the AI investment boom.
And little to fear from a Federal Reserve poised to hold rate policy steady.
The earthquake election results out of Brazil provided the first speed bump.
Bouncing off intraday lows, Brazil’s Ibovespa ended Monday’s session down 13.9%.
The Brazilian real sank 8.06%.
Local currency 10-year yields spiked 230 bps to an 18-month high of 15.12%, as dollar-denominated yields rose 22 bps to 6.50%.
October 30 – Bloomberg (Barbara Nascimento, Leda Alvim and Vinícius Andrade):
“In the span of three weeks, Brazilian hedge-fund managers went from celebrating some of their biggest gains in years to nursing steep losses and issuing mea culpas to their clients.
The bullish bets that delivered windfall profits after Flávio Bolsonaro’s surprisingly strong first-round showing on Oct. 4 blew up spectacularly after leftist incumbent Luiz Inácio Lula da Silva’s victory in the presidential runoff on Sunday…
Local macro hedge funds lost as much as 24% on Monday, the worst day of the rout...
For the industry broadly, it was the worst day in about nine years.”
Bolstered by Anthropic’s IPO filing and an announced $63 billion Broadcom financing, Brazil’s market accident was largely dismissed.
The Semiconductor Index jumped 2.8% in Monday trading, with the Nasdaq100 gaining 1.1%.
Bullish sentiment was supported by the 12 bps drop in French bond yields (“France Spared Moody’s Ratings Downgrade as it Struggles with Unrest”).
The France to Germany yield spread narrowed a notable 14 bps (to 154bps) – the biggest one-day narrowing since 2020.
Bullish tech sentiment intensified Tuesday.
The initial tranche of Meta’s massive $98 billion equity raise was said to be five times oversubscribed.
The company sold $25 billion of common shares, along with $12.5 billion of preferred stock.
In South Korea, SK Hynix reported a seven-fold jump in earnings, with the KOSPI Index surging 3.1%.
The Semiconductor Index surged 3.6% Tuesday, with the Nasdaq100 rising 1.3%.
“Neocloud” Nebius and CoreWeave stocks jumped 11.2% and 7.9%.
Intel rose 3.6%.
High yield spreads (to Treasuries) narrowed a notable 15 bps Tuesday, with a two-session narrowing of 24 bps.
Wednesday was Federal Reserve and Oracle Day.
I’ll return to the Fed. Tech sentiment was boosted by the KOSPI’s 6.6% Wednesday advance.
Oracle surged 11% on renewed enthusiasm following company forecasts of longer-term earnings and cash flow growth.
Oracle (’36) yields sank 19 bps to 7.47%, while its CDS dropped 22 bps to a two-week low of 274 bps.
Stocks edged higher following Warsh’s press conference.
The Semiconductors rose another 1.8%, boosting w-t-d gains to a chunky 8.4%.
The Nasdaq100 closed Wednesday’s session with a 3.0% w-t-d advance.
The VIX ended Wednesday below 17.
But things began to sour only minutes after the close.
“Alphabet Sinks 10% [afterhours] as it Holds 2026 Capex Unchanged, Expects Significant Increase in 2027.”
“Google Shares Tumble 10% After $51bn AI Outlay Deepens Cash Burn.”
“Alphabet Sheds Half a Trillion in Market Value in Stock’s Worst Ever.”
“Alphabet Plunges by Record with AI Exposure Topping $1 TN.”
The fragile tech rally began to falter Thursday.
Google ended the session down 13%.
But for the most part, the tech sector maintained its composure.
The MAG7 fell 1.8%, with the Nasdaq100 and Semiconductors down only 1.4%.
Microsoft enjoyed huge demand for its $25 billion bond offering.
Things started to head south after Thursday’s close.
Amazon slumped as much as 7%, while Intel plunged 25%.
Further darkening the mood were revelations of the alarming scope of a hack at crypto heavyweight Binance.
Bitcoin ended the day down $2,500, or 3%, to $79,000.
Friday got off to a rocky start in Asia. South Korea’s KOSPI dropped 3.5%, with Taiwan’s TAIEX down 2.5%, and Japan’s Nikkei 225 Index losing 2.1%.
China’s CSI 300 fell 1.4% to a 15-month low – down 2.9% for the week and 8.5% for the October.
China's growth-oriented ChiNext Index sank 4.1%, pushing the losses of week and month to 10% and 23%.
With Intel down about 30%, the Semiconductor index opened the session 5% lower.
Things turned panicky.
At intraday lows, the Semis were down over 9%, with the Nasdaq100 sinking 4.4%.
The VIX spiked to 24, the high since early April.
High yield CDS popped 12 to 364 bps, near the high since April’s market instability.
A rally in the session’s final hour cut Semiconductor and Nasdaq100 losses to 7.2% and 3.5%.
The VIX backtracked to 19.4, while high yield CDS retreated to 356 bps (down 7 on the week).
A headline not read every day:
“Crypto Industry Suffers ‘Largest Bank Heist in Human History’ as Billions Stolen in Binance Hack.”
After trading up to $81,870 in Thursday evening trading, bitcoin slumped 6.9% Friday afternoon to a six-week low of $76,189.
Friday was surely another brutal day for the hedge fund community.
Tech stocks were hammered, along with crypto and the precious metals.
Gold dropped 3.7% Friday, with Silver slammed 5.9%.
It’s worth noting Friday’s unstable European bond market.
French 10-year yields rose six bps to 4.97%, while German bund yields declined three bps to 3.32%.
The France to Germany spread widened a notable nine bps (165bps), with spreads also widening four for Italy (119bps) and Greece (97bps).
It was also interesting to see that Friday’s risk off session was worth less than a basis point reduction for “safe haven” 10-year Treasury yields.
October 30 – Bloomberg (Zahra Tayeb):
“Bonds of US technology firms are trading at their weakest in more than two decades relative to the broader corporate debt market, after companies… flooded investors with hundreds of billion of borrowings to fund artificial intelligence investments.
The average risk premium, or spread, on investment-grade technology bonds stood at about 1.02 percentage points as of Thursday’s close, about 0.15 percentage point higher than the average spread for the market at large.
That’s near the widest gap between the two since the aftermath of the internet bust in the early 2000s…”
Tech stocks are certainly interesting, but the critical action is with technology Credit.
The market can either fund the Trillions required for the AI buildout - or it can’t.
With de-risking/deleveraging gaining momentum, prospects are not good.
October 28 – Bloomberg (Giulia Morpurgo, Nishant Kumar, Reshmi Basu, and Irene Garcia Perez):
“For as long as Hamza Lemssouguer has traded high-yield debt, he’s been on the offensive, placing bets at a scale few in the cutthroat market dare to match.
These days, though, the 36-year-old founder of Arini Capital Management is in the uncomfortable — and unprecedented — position of licking his wounds as the riskiest corner of the European junk-debt market that he’s dominated for years is slumping around him.
Arini’s flagship fund, which had $7.5 billion in assets under management at the end of July, was down 12% for the month through Oct. 23 and around 26% so far this year…, on track for the first annual loss since Lemssouguer started trading for his fund in 2022…
The withdrawal of buying power from Arini — one of Europe’s fastest-growing hedge funds — has intensified investor fears about a junk-debt market that was already facing an array of challenges.”
October 30 – Bloomberg (Laura Benitez, Reshmi Basu, Irene García Pérez, Giulia Morpurgo and Nishant Kumar):
“Arini Capital Management, which has been beset with losses this month, has gotten bids on some of its high-yield debt holdings from asset managers including Pacific Investment Management Co. and Oaktree Capital Management…
It’s been a remarkable turn for Lemssouguer, 36, who was a star trader at Credit Suisse and continued to produce stellar returns at Arini by purchasing the relatively illiquid debt of large firms with lower credit ratings.
For years it has been one of the fastest-growing hedge funds in Europe, becoming a $21.7 billion credit-trading giant after starting out at $1 billion in 2022.”
From a billion to almost $22 billion since 2022, phenomenal growth during a historic period of hedge fund speculative leveraging and liquidity abundance.
Hamza Lemssouguer was an 18-year-old teenager during the 2008 crisis.
Enough years have passed since the “GFC” to ensure that Wall Street and global market trading are dominated by aggressive young traders who have accumulated incredible wealth (and assets under management) playing loose with risk and leverage.
Bubble don't work in reverse.
And so long as strong performance (“alpha”) and fund inflows were ongoing, a steady stream of new money was available to build only bigger positions (at higher prices).
Liquidity mattered little.
Rather quickly, it today matters a lot – for Arini Capital Management, the leveraged speculating community, and markets more generally.
Losses, outflows, deleveraging, and liquidity issues mark the onset of a major cycle transition.
In the context of a major Credit cycle transitioning period, the Credit default swap (CDS) marketplace is receiving some newfound attention.
“Credit Swaps For Tech Companies Reach Records Amid Supply Fears.”
Importantly, AI financing kingpin Nvidia’s CDS surged 16 bps Friday to a record 144 bps – with an alarming 48 bps two-week spike.
Nvidia CDS traded below 40 in early-June, and was as low as 81 earlier this month.
SpaceX CDS jumped 13 Friday to a record 283 bps – with an equally alarming 33 bps two-week spike.
SpaceX CDS traded at 150 on September 18th and 110 in June.
SpaceX (’36) bond yields rose another two bps this week to a record 7.62% (2-wk surge 42bps).
Amazon CDS surged nine Friday to a record 96 bps, with a two-week gain of 20 bps.
This CDS traded at 54 in mid-August.
Google/Alphabet CDS jumped 10 Tuesday to a record 88 bps (closed week at 76) – after trading at 47 bps in June.
Closing the previous Friday at a record 127 bps, Meta CDS had pulled back to 113 by Thursday – only to surge back to 125 by Friday’s close (traded below 70 in June).
October 30 – Bloomberg (Davide Barbuscia and Riley Griffin):
“S&P Global Ratings lowered the outlook on Meta Platforms Inc.’s AA- credit rating to negative on Friday, citing growing pressure on the tech company’s balance sheet stemming from elevated spending tied to artificial intelligence.
‘Meta’s ability to monetize its AI investments is more limited than that of its peers,’ the credit rating company said…”
Oracle CDS spiked 25 bps Friday, while ending the week down 20 from the previous week’s record close.
When Credit and liquidity conditions are loose, selling Credit protection is like writing flood insurance during a drought.
Easy, alluring “money.”
And as the crowd rushes to participate, the surge in CDS selling is accommodated by market makers that take the other side of the trade (long CDS) and hedge such exposures by holding the underlying bonds – with leverage, of course.
This buying creates demand for corporate Credit, while generally bolstering marketplace liquidity.
But when the Credit cycle turns, supply and demand dynamics flip.
Losses on corporate bonds trigger demand for CDS protection and rising CDS prices.
Faced with mounting losses, the speculators who had written “flood insurance” move to unwind their positions, with the dealers on the other side of the trade reversing their hedge (sell bond holdings).
Meanwhile, an upsurge in market demand for CDS protection finds the accommodating dealer community selling CDS and, this time, simultaneously shorting bonds as their hedge.
The shift in Credit, market, and CDS dynamics has major ramifications for marketplace liquidity.
The big AI players have huge amounts of outstanding debt and, supposedly, hundreds of billions in the pipeline.
The CDS marketplace faces its greatest test yet.
“Fed Officials Make Case for Rate Hikes Amid Ongoing Inflation Concerns.”
“Fed Needs at Least Two More Rate Hikes, Logan Says.”
“Fed’s Musalem Says a Rate Hike is Needed ‘Soon’.”
“Fed’s Barkin Says US Central Bank’s Direction ‘Straightforward,’ the Question is Pace.”
There would be nothing noteworthy from the above headlines, except that Fed officials Friday publicly called for rate hikes, just as de-risking/deleveraging gained important momentum in the markets.
And as much as I respect Richmond Fed President Thomas Barkin, things will be anything but “straightforward.”
The Fed is ill-prepared for what is unfolding in global markets.
Federal Reserve reform is long overdue.
I appreciate the direction Chair Warsh is moving, with financial conditions at the forefront.
“We have started to see some changes in financial and credit conditions.”
“And while overall financial conditions are tighter, I’m unwilling and unable to call them tight.”
“The Committee had a good discussion of the changes in the economic and financial landscape.”
“You’ve seen credit spreads for certain assets widen out, gap out.
For others you’ve seen some tightening in financial conditions, but not significantly.”
“I would say the effects on financial markets, on financial market conditions broadly were consistent with my expectations.”
Warsh’s analytical framework would have been beneficial over the past few years of extremely loose conditions.
Today, at a super cycle inflection point, I suspect the financial conditions focus will justify an early end to rate hikes.
There’s a big caveat here.
A major short squeeze and unwind of hedges could materialize at any time.
Financial conditions might turn incredibly unstable – from deleveraging and illiquidity to abrupt short squeeze-induced market rallies and bouts of loose conditions.
With economic overheating and elevated inflation, surging market prices and resurgent inflation would beckon for higher interest rates.
At this point, however, I posit that there is greater likelihood of deleveraging and tighter conditions.
Chair Warsh is clearly focused on AI and market dynamics, and I doubt his committee would raise rates into stock market and technology debt issues.
After beginning the week at 91%, the market ended the week pricing a 73% probability of a rate hike at the December 9th meeting.
Chair Warsh:
“The dominant means in which this policy is going to be put into practice is we are tightening financial conditions.
They’ve tightened a bit since we met last time.
That isn’t something that we’re uncomfortable with.
That tells me that policy is working…”
In a different backdrop, I would applaud the Fed’s focus.
Warsh is signaling to market participants to key off financial conditions.
If speculation and leveraging foster loose conditions, be prepared for tighter policy.
The old “lean against the wind” approach, which would have been so valuable during years of excessively loose conditions.
But it’s so late in the game.
A problematic tightening of market conditions will surely trigger the traditional response of easier monetary policy.
Warsh:
“At this point, the balance sheet is solely within the four walls of the Balance Sheet Task Force.
Now I have checked in with them… and I think the conclusions they come to, the recommendations they come to, will be fed into the FOMC probably early in the first quarter…
And if we decide to make changes in the balance sheet, it’ll be after a serious consideration of their proposals and their recommendations.”
Such comments are not “Fed put” confidence inspiring.
I doubt the Fed will enjoy the luxury of waiting for Q1 2027 direction from the Balance Sheet Task Force.
And this gets back to the critical issue of the speed and scope of Fed QE when speculative deleveraging turns highly destabilizing.
It seems the world changes next Tuesday.
Markets assumed the “Trump put” would be in full force, at least through midterms.
Now we’re only days away from a possible “blue wave” and unpredictable Trump administration backlash.
The world might be days away from the resumption of hot war with Iran – one the Iranians have had months to prepare for.
It’s been an interesting close to midterm campaigning.
Faced with intense questioning at the February House Judiciary Committee oversight hearing, Attorney General Pam Bondi strangely kept commenting on stock prices.
Of late, not even President Trump seems keen to mention the stock market.
It’s as if inflating stock prices have finally reached the point where they’re no longer the most coveted political asset.
This protracted cycle of historic asset inflation and rising inequality has turned precarious.
Going forward, it seems stabilizing bond markets – Treasuries, AI and corporate debt, MBS, and munis – will dominate Washington policymaking.
This cycle transition will be destabilizing and intensely challenging.
For now, it’s become such a minefield out there.
0 comments:
Publicar un comentario