Former trader Richard Breslow is out with his daily missive and Wednesday’s installment may very well be one of his best efforts ever.
First of all, Richard is sticking his neck out on this one. “I’m officially declaring today the very start of the entire change over process,” he notes, not necessarily calling the top, but rather calling for the return of the kind of two-way markets that ceased to exist years ago. Of course this is a largely riskless proposition for Richard. Because if he’s wrong, I bet you won’t have the balls to tell him. We’ve seen his colleagues go back and forth debating the merits of the dedollarization thesis and all manner of other contentious points, but we’ve yet to see anyone challenge Breslow to a Hamilton-Burr-style duel. Here’s hoping, though.
Breslow’s contention rests on the assumption that the Fed is going to be disappointed in the extent to which the ECB and the BoJ will be willing to effectively allow the U.S. to get out ahead of everyone else on normalization without suffering any consequences in terms of the deleterious effect a coordinated global normalization would have on risk assets. The Fed’s assumption seems to be that as long as Draghi and Kuroda are still writing puts, the committee can unwind the balance sheet and lean hawkish with impunity. That is, other central banks will ensure there’s not a market mutiny which, by virtue of the communication loop between the Fed and investors, would be the equivalent of getting screamed at. The Fed then, is betting on a free ride.
That isn’t likely to pan out, Richard contends. And not necessarily because of the usual spiteful dynamics that accompany currency wars – but rather because the rest of the world simply won’t be able to afford it or otherwise suffer the pain.
Read below as Breslow spells it all out for in a truly fantastic piece…
As the long running debate about lack of volatility in the markets continues, I’ve got some good news for you. As long as you promise to be happy with what you wish for. It’s about to change. Sure we have momentary bouts of hysteria which people get all excited about and extrapolate to eternity–until they run out of steam forthwith. I’m talking about good old fashioned two-way flow and nascent trends galore. And I’m officially declaring today the very start of the entire change over process. Wouldn’t it be ironic if future generations of traders celebrate this epiphanic moment of a return to volatile markets by shutting the exchanges and sleeping in?
- So what’s the big news? I’m glad to say it isn’t war or some other catastrophe. Those have become anti-volatility events, for better or worse. The big news is the release of the FOMC minutes. Now before you get excited, or derisive, I don’t expect any profound surprises. I’m not even all that consumed by the inevitable wrangling over why inflation isn’t showing up in the measurements they’ve chosen. It’s that this is the true start down the road to tapering. Which I expect to start very tamely, orderly and with many pats on backs
- So what’s the catalyst? It’s the next phase of the free rider problem. QE worked because those benefiting from the appropriation of the public good, namely central bank balance sheets, were the ones in charge. In every sense of the word. And if you were a member of the class of citizens that got left behind you were assured that it was your patriotic duty to accept it gratefully. And by the way, what are you going to do about it?
- This was only sustainable and achievable because everyone in the developed world hegemony was doing it in tandem. My low rates are your low rates. As are my equity prices and suppressed volatility. Now that was true globalization. But this is going to change
- The Fed is confident their tapering plan can work because they comfortably assume that the other central banks will let the U.S. enjoy free ridership from their ongoing asset purchases and ridiculous rate structures. That surmise may seem reasonable at the outset, especially with the initial numbers so small. And ultimately prove to be just a bridge too far. And it doesn’t have to be so out of any jealousy, malice or the kind of pettiness that causes all those occasional outbreaks of currency wars
- The issue for the other countries will be that once the U.S. has begun to meaningfully get their balance sheet in order and follow some version of the medium-term dot plot, there will be no protection from global rates being forced collectively higher. And equity markets will realize what’s coming. Sheer survival instinct will force the ECB, BOJ, and others to move forward their own normalization plans. From the lowest of levels. They’ll have no choice or risk be left high and dry, with very few options of their own. And investors, too, aren’t prepared for it
- It is simply asking too much for the Fed to expect everyone else to smooth their transition, eliminate any pain, make them the heroes and then announce, like a scene from Blazing Saddles, “Son, you’re on your own.” No one is isolated or isolatable and friendship only goes so far
- Those wily foreign exchange traders are the first ones to get this. Probably because they benefited the least from the actions of the last decade. It makes perfect sense to like the dollar given the divergent central bank cycles out there, but they can’t help understanding that there will be plenty of room for other sovereign rates to snap higher at some point and that is when two-way price action becomes intense
- It is this free ridership problem that should frame the debate over a hawk or dove becoming the next Fed Chair, not whether we should expect an extra hike somewhere down the line
Dying is easy, change is hard. It is very difficult to warehouse a long vol position in the absence of negative convexity. Unilateral Fed exit is self-attenuating (rising $–> tighter financial conditions), so rise in fx vol will be episodic, at best
— Bjarne Knausgard (@BjarneKnausgard) October 11, 2017