How many times have I talked about a “breaking point” for markets in September? A lot. The answer to that question is “a lot.”
In fact, I even used those two words, by themselves, as a title on September 16. The “breaking point” talking point (if you will) is more than a recurring theme. And it’s not lazy shorthand for “something’s gotta give,” that most trite and nebulous of clichés. Rather, it’s the lens through which almost all market coverage should be contextualized when the dollar’s rising inexorably and US real rates are marching higher not on an improving growth outlook, but on expectations for Fed tightening.
On Thursday evening, hours before the pound plunged alongside a historic meltdown in gilts, I wondered if everything was about to “come apart.” I cited the franc’s Thursday plunge (which came despite a large rate hike) and the first yen intervention since 1998, while suggesting that the “rapidity, frequency and size of ongoing policy adjustments” and accompanying gyrations across assets was indicative of a very precarious conjuncture for markets of all sorts. I went on to say that “markets as we’ve come to know them over the past decade (or three) were built on a set of assumptions which no longer hold,” before recapping “You Break It, You Buy It,” a sort of prequel to “Breaking Point,” in which I cautioned the dollar’s roughshod run, predicated on an increasingly aggressive Fed path and the attendant run higher in US reals, was pushing markets to the precipice. Later Friday, in “Wrecking Ball,” I tacitly (and then, in the comments, explicitly) contended that if things continue to unfold as they did this week, the Fed, in conjunction with Janet Yellen’s Treasury, may have to ponder options for arresting the dollar’s run, a vexing situation given the necessity of tighter monetary policy to fight domestic inflation.
As it happens, the editors over at Bloomberg were thinking along the same lines. The exact same lines, actually. This (wholly coincidental) mind-meld produced an article called “Wall Street Risks a Breaking Point,” which described “extreme moves flaring up across asset classes” along with “freakish gyrations,” which together suggest a “tipping point” might be “dangerously close.”
I agree! I couldn’t have said it better myself. Or, actually, I could’ve. And I did.
Putting away my wry smile, which in this case is very close to being an unqualified smirk, it’s good that this gets mainstream attention. Too often, the financial media fails to connect the dots, not because they aren’t capable, but rather because the manic pace of article generation required to make it look like “news” is always “breaking” (Bloomberg is just CNN in that regard, red chyrons and all), means perpetually missing the forest for the trees.
I do understand the business imperatives behind that sort of coverage at Bloomberg. They’re trying to marry up respectable journalism with the rapid-fire pace of markets. Real markets. Not just “the stocks,” which is all that matters over at Sesame Street. But there’s always going to be tension there. Because that’s not what journalism (financial or otherwise) is about. It’s not “Here’s 8,000 trees. Now go build a forest.” Rather, as a journalist, you’re supposed to show people the forest. The public is already lost in the trees. Bloomberg often doesn’t seem to understand that. The Financial Times does. And I do, despite never having worked for, with, or in any sort of proximity to, a mainstream media outlet.
In any event, the figure (below), neatly encapsulates the problem. It shows why assets of all sorts are reaching a breaking point. Markets expect policy rates in the US to be ~4.6% early next year (consistent with the Fed’s new dot plot), the dollar won’t stop rising and with the exception of two interludes (one coinciding with the risk-off event and attendant commodity-driven surge in breakevens around Russia’s invasion of Ukraine, the other contemporaneous with the summer stock surge), US real yields have exerted a near constant tightening impulse.
It’s impossible for risk assets to find their footing in this environment and, as discussed at some length here on innumerable occasions of late, 2022’s unique circumstances mean that virtually everyone is imperiled, not just the usual suspects (e.g., EMs and richly-valued equities).
This week was a testament to that peril. If US officials aren’t careful, the last few days could be seen in hindsight as a prelude to catastrophe.
The yen is broken. And there’s no way out for Japan absent US help. The finance ministry is likely to intervene further (interventions have historically come in clusters), but they risk making the situation worse as long as Haruhiko Kuroda won’t let JGB yields rise. “Bona fide intervention would necessitate selling large quantities of US bonds… and if their sale causes US yields to rise, this could support yen depreciation by widening the yield differential between the US and Japan,” Goldman’s Naohiko Baba remarked. “In light of these risks which could result in intervention being counterproductive, we had thought intervention was unlikely.”
Goldman underscored the same paradox I’ve variously suggested is simply too cumbersome for the market to happily countenance. “We think the key going forward will be the way in which the market digests the approach of the government and the BoJ to tackling the forex issue, which on the one hand involves pushing ahead with powerful monetary easing that results in larger yield differentials — the main driver of yen depreciation — while on the other hand intervening in the forex markets to prevent yen depreciation,” the bank remarked.
The euro, meanwhile, seems a lost cause. Much like inflation in Europe, the fate of the single currency depends more on the scope and duration of the energy crisis than it does on monetary policy. And the energy crisis depends on the war.
The idea that Christine Lagarde can somehow rescue the currency by “out-hawking” Jerome Powell is far-fetched. For one thing, neutral in Europe is almost surely lower than it is in the US. And the fragility of the bloc’s economy means the ECB probably can’t afford to venture too far into restrictive territory. So, at best, Lagarde will run mildly restrictive policy above a relatively low neutral rate. Powell, by contrast, intends to run very restrictive policy atop a higher neutral rate. And all of that’s to say nothing of the fact that Lagarde is ~200bps behind Powell already. Small wonder the euro is beset (figure below).
This was among the worst weeks for the currency since the debt crisis. The weaker the currency, the more pass-through inflation and the higher the bloc’s import bill, which in turn means deteriorating fundamentals, and more pressure on the euro.
Meanwhile, the UK is staring into a deep, dark abyss. I don’t think most market participants have fully internalized how bad Friday was.
The one-day increase in 10-year yields was the largest ever. There has never, in the history of Bloomberg’s data anyway, been a larger single-session selloff in 10-year gilts (figure below).
The fact that the collapse in UK bonds occurred alongside the third-largest decline for the currency in two decades isn’t just a “warning sign.” It’s a precursor to what, if the Truss government isn’t careful, could easily snowball into an overnight crisis. It was obvious on Friday (blatantly obvious) that Truss’s government doesn’t understand how close to the edge they are.
Reading through Bloomberg’s “breaking point” piece, it’s apparent that at least somebody involved — whether it’s Lu Wang or Shery Ahn or Haidi Lun or Vildana Hajric or Lisa Abramowicz or Sebastian Boyd who, I should note, is a smart guy — understands why this is especially dangerous in the 2020s. Modern market structure was built atop stable correlations, low inflation and ever easier developed market monetary policy, and built around generally subdued cross-asset volatility. It isn’t calibrated for this sort of environment.
In the piece, Bloomberg referenced VaR shocks. “Big asset managers operate under risk-management frameworks where rising volatility often necessitates the unloading of portfolios,” the article-by-committee said. But it’s not just “big asset managers.” It’s market makers too, both carbon-based and otherwise. Liquidity is structurally impaired — so, impaired anyway, irrespective of adverse market conditions. Now, everything is blowing up. That combination is conducive to spreads blowing out. The Fed can always close bases, but the concern currently is that doing that would be tantamount to easing, which is counterproductive to the inflation fight.
You can draw your own conclusions, but my contention is that absent some series of fortuitous turns (and we, as a species, haven’t been very lucky in the 2020s), global markets may implode over the next two months.
Jerome Powell on Friday said the Fed “continue[s] to deal with an exceptionally unusual set of disruptions.” He was speaking to business and community leaders at another “Fed Listens” event in Washington. I’d gently suggest the Fed hold its next “listening” event on Zoom, with global finance ministers and central bank chiefs, before Powell ends up having to add “global financial meltdown” to a resume that already includes three bear markets, two recessions, a pandemic, a short-lived depression (with a “d”) and an inflation crisis.
“Modern market structure was built atop stable correlations, low inflation and ever easier developed market monetary policy, and built around generally subdued cross-asset volatility.”
To this list I would add opaque derivatives and ridiculous levels of leverage. Unconstrained speculation made a lot of people very, very rich. Now it looks poised to take down the global economy — and, perhaps, democracy with it.
Step one, export demand destruction. Step two, import cheap stuff.
Actually, I think we still are importing plenty of cheap stuff and it certainly won’t tamp down prices if we decide to bring everything onshore. Not enough workers, nominal wages rising, and input costs rising. Got to go cheap.
My fear is that VaR shocks trigger “political” actions. I’m less worried about the Fed, far more worried by politicians. That makes the Dollar a potential “shock”. And, hey. We ain’t talking about that one…
H, your note could be taken as hyperbole during a period in which the usual bear suspects have been given the microphone while the perma-bulls are somewhat sidelined. Or the note can represent a scolding to those that have not bothered to take steps to limit losses — basically with cash. The cadence of the your negativity has definitely picked up over the last few weeks as you have interjected more of you own thoughts as compared to the thoughts of the various banks’ analysts.
I appreciate your thoughts and directness. But I must admit, your fear of a global financial crisis (of some sort) has given me a bit more pause. Anyone that has moved to essentially cash months ago worries about when to get back into the market. But, like you, I just don’t feel that this is the time even with the massive drops in bonds/treasuries and more than a pedestrian drop in equities. Therefore, my thought is, “Wait for the Feds to reverse course due to stuff breaking badly…” It might be a while.
I’m not “the usual bear suspects.” I write what I happen to be thinking at any given time. People often ask how I can write multiple articles every, single day with no “days off” in over six years, and the answer is because it’s like a conversation for me. Marooned as I am (both figuratively and literally), this is where I talk to people. So what you’re getting here is what I’d be talking to people about in person if I had anyone to talk to. It’s not an editorial agenda, which is why it can be bearish, bullish, noncommittal or anywhere in-between.
Well, thanks for taking the time to “talk” to us
Your are not in the camp of “the usual bear suspects” in my mind.
The point I did not make very well, is that when a bear market displays itself, the perma-bears get the microphone and during a bull-market, the perma-bulls are handed it instead. You on the other hand, do not camp in either. Therefore, I respect your musing/opinions more so. And because of that respect, I am given more pause relative to the current state of markets.
I believe I have been reading your notes since the beginning (2016). During that time, I cannot think of a period where you have been this explicit in about being careful.
I remember clearly H’s warnings in late 2018, late 2019, and late 2021. All saved me pain and misery.
I agree with you. This last warning stands out.
As a longtime leader and first time comment, I would say this is the problem. You have no one to talk to. We read what you write but we cannot engage you in a conversation. Therefore we cannot truly vet or learn from your insights.
This is the path that you have chosen. But please know, this is not “talking to people.“
Maybe, after several years of isolation, it is time to engage in real conversation. It would certainly benefit those of us who read your thoughts, And maybe, just maybe you would find some benefit in it as well.
You can’t learn anything from me because you can’t engage me in a personal conversation? That seems to rule out learning from anyone who’s died. Which is unfortunate, because I’ve learned a lot from dead philosophers, novelists, political thinkers and economists. If I’d known not being able to talk to them was a prerequisite for learning from them, I could’ve saved a lot of time!
Jokes aside, the fact that I’ve been here every, single day for almost seven years, the fact that I share all manner of personal anecdotes within my macro, market and geopolitical musings, and the fact that I engage with subscribers over email literally every day whenever they have run-of-the-mill questions about the site (e.g., “How do I find your latest article on XYZ” or “How do I change my display name in the comments?”) should be all you need. What I promise readers is precisely what I deliver. Also, I’d note that I’m not a “mystery” to everyone. There are dozens of people (on Wall Street and in the mainstream financial media) who read this site every, single day who know exactly who I am.
Here is a solution to an overvalued strong dollar. Keep hiking rates until the USA experiences a brutal recession. Inflation comes down and the fomc has to stop qt and cut rates. Falling economic outcomes trash the dollar. It’s all good! (Sarcasm)
The fed are between a rock and a hard place. If they continue raising interest rates at the current pace the dollar soars and the world burns. If they back off and take a break the US stock market and inflation soar. So IMHO they need to find common ground. Maybe the next raise will be much less say 40 basis points (I assume that’s possible) and the fed will monitor what happens. I also think the war will end soon with Putin having a heart attack or falling down the stairs lol.
“If they back off and take a break the US stock market and inflation soar”
The stock market, sure, it’s a bit stupid but mechanical. Inflation? Not sure at all. Inflation isn’t a magic thing. It has to come from somewhere… What do you think are the drivers of current inflation? Do you see them persisting in the future?
If we switched back to risk on? Yes. Housing could again become a problem instead of a solution, commodities would likely swing the ‘wrong’ direction. You could quickly find yourself staring down significant inflation once again.
The supply side has not been fixed when it comes to… essentially everything. If the demand side were to cease being hammered down we’d be right back where we were.
OK. Risk, uncertainty and ignorance. If you prefer, the known, the unknown and the unknowable. In 2019, we had an in inverted yield curve, in early fall the overnight market went into complete disfunction, and late in the year the smartest technicians I know told me the stock market was about to decline 30%. Three strikes and you’re out? Did the market forecast covid? Here we’re slowly coming out of a 3 year global pandemic which wreaked havoc on supply and the supply chain, We’re looking at a new philosophy on the supply chain of national security instead of deflation, China is experiencing serious economic problems and is riding the tiger of nationalism and racism and facism at home….Need more? Climate change- reaching critical mass. Right wing populism reaching critical mass. I’ve saved the best for last- the US, UK and Nato are at war with theSoviet Union’s malignant stepchild. Unraveling empires are incredibly dangerous. 1916-the Turks murder 3 million Christians , of which half are Armenian. I don’t think the market has any pricing response to this clear and present danger. Not frightened? On September 15, Cramer revealed he bought the US 2 yr in his personal account. Now, these are facts- the markets are more of a psychology play than a scientific argument. But the markets are never wrong- people are…….
Question for the cinematically minded- Is Vladimir the new Fredo?
Globally, too many workers left the workforce at the same time. This is a huge shock to our system.
This seems to have happened for a variety of reasons and which are taking a lot longer to (hopefully) resolve/digest than anyone expected. We might have gone too far in the direction of money printing; handing out unprecedented amounts of cash; providing excessive amounts of credit – with the unanticipated result that workers now demand to work far less (or not at all) than they did pre-covid. This shift in workforce expectations would have been much less difficult to manage if that change had occurred slowly instead of all at once- for example, we could have gotten to 4day work week and UI in a transitional manner without the chaos.
The goal of monetary and fiscal policy should be to incentivize people to return to the workforce before, globally, we permanently have even more people than we actually need. Corporations might end up automating even more of what previously used to be done by people. What to do with all of the non-contributing people who just want cash handouts?
The “rules” and manner in which we function are changing- and the market does not know if we are going back to “the way we were” or if seismic changes are occurring- and, if so, what they might mean.
Don’t forget, not only are higher interest rates restrictive, so are higher prices. Jim Rogers constantly says the cure for high prices is high prices. I’m watching to see how traders with less than ten years experience deal with this market. I’m also amazed at the lack of patience shown by the leaders of the world financial system.