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Kolanovic: All The Carry Trades Can’t Be Bailed Out
JPMorgan's Marko Kolanovic has a message for markets: "There are many carry trades, and they can't all be bailed out."
That was the title of the bank's latest asset allocation update, which found Kolanovic and co. retaining a defensive tilt in their model portfolio. They increased their Underweight in equities and raised their cash allocation.
To briefly recapitulate, Kolanovic turned cautious towards the end of last summer, and has retained that bent since. Last week, two days prior to the SV
Whenever the yield curve goes negative, the search begins for reasons why “its different this time”. Most recently, some bulls were calling the current yield curve inversion merely an artificial construct of Fed hikes, no longer a reliable economic signal.
The yield curve is a primary input into the economy, not merely an output signal. Banks employ one of the higher-visibility and highly-leveraged trades, but as Hartnett, Kolvanic, H, and others have noted, there are many other carry trades vulnerable to inversion.
Inverted yield curves break (financial) things, some expected and others surprising. I imagine we’ll see more things break. The question will be if the breakages can be patched (BoE-Gilts, Fed-regional banks) or cannot, and how willing the Fed is to risk the breakage by pressing on with its inflation fight.
That last might depend on the Fed’s awareness of the potential and size of breakage and view of its ability to patch.
For bank asset-liability duration mismatch, I am fairly confident “the Feds” (Federal Reserve, Treasury, FDIC, etc) were aware there was a growing risk for which it had the necessary tools; the Feds know this aspect of the economy well. Shadow banking feels at the other extreme; I am less confident that the Feds know what to expect and I doubt their toolkit reaches there (for legal reasons). CRE might be somewhere in between.
Good comment. My bone to pick with the Fed was leaving qe on too long, then compounding the mistake with qt and a far too aggressive pace of tightening by raising rates. I was taught years ago in my money and banking course that regulation is one form/tool of monetary policy. Policymakers and politicians seem to ignore this. But about every 10 years we get this lesson again. The market also underprices counterparty risk with even more frequency. We are once again learning the hard way.
Look on the bright side – with all the indexation, passive investing, and ETF trading, there are always some good names that get unfairly thrown out with the KRE bath water, creating opportunities for us.
I spent the whole day manually pulling numbers from schedule RC-B of FFEIS 031 forms, trying to figure out which regionals might be opportunities. Along the way I realized one reason why these events have surprised generalist investors. The key data is not available on the common market data platforms, at least not the one I use which is the one that most buysiders use, so it’s hard to build screens and alerts.
Of course the street analysts have juniors pulling the numbers manually and writing notes, but how much time do most generalist PMs have for the junior sellside analyst assigned to cover regional banks, who might be extra credulous anyway because s/he only has a few years’ experience which didn’t include GFC?