'It was one of those weeks that left an unsettled feeling in the pit of my stomach. A lot of money was lost in the cryptocurrencies and high-flying tech stocks. Before this is over, astonishing amounts of perceived wealth will have vanished into thin air. Tens of millions of unsuspecting “investors” will lose meaningful amounts of their savings. They bought into the mania, threw caution to the wind, and will suffer the consequences. Blindsided.
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While appearing miraculous on the upside, I have long argued contemporary finance doesn’t function well in reverse. So long as Credit and speculative leverage are expanding, markets will appear highly liquid, financial conditions will remain loose, and asset price inflation will maintain self-reinforcing momentum. But fragility lies in wait – just below the surface. Derivatives – they lurk as an accident waiting to happen. And the lying and lurking can persist for years, long forgotten but ready to pounce.
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Market Structure is becoming a huge issue. Contemporary Finance Doesn’t Function Well in Reverse – and that’s an understatement. Illiquidity and mayhem. Rather than “Ring a Dot-Com Bust Alarm Bell,” it was the systemic risk bells that began chiming this week.'
- Doug Noland,
Market Structure in the Crosshairs, January 22, 2022
'..We have the good fortune of having one of the great Credit and macro thinkers of our age still with us – and providing astute analysis - at the age of 94. For those unfamiliar with the esteemed Henry Kaufman, he was a Fed economist before becoming a Wall Street legend in the seventies as chief economist and head of bond market research at Salomon Brothers (my analytical framework owes a great debt to Dr. Kaufman). Kaufman Knows Inflation.
Henry Kaufman was interviewed this week for an article by Bloomberg’s Erik Schatzker:
“I don’t think this Federal Reserve and this leadership has the stamina to act decisively. They’ll act incrementally. In order to turn the market around to a more non-inflationary attitude, you have to shock the market. You can’t raise interest rates bit-by-bit.”
“The longer the Fed takes to tackle a high rate of inflation, the more inflationary psychology is embedded in the private sector -- and the more it will have to shock the system.”
“‘It’s dangerous to use the word transitory,’ Kaufman said. ‘The minute you say transitory, it means you’re willing to tolerate some inflation.’ That, he said, undermines the Fed’s role of maintaining economic and financial stability to achieve ‘reasonable non-inflationary growth.’”
“If he were advising Powell, Kaufman said he’d urge the Fed chair to be ‘draconian,’ starting with an immediate 50-bps increase in short-term rates and explicitly signaling more to come. Plus, the central bank would have to commit in writing to doing whatever is necessary to stop prices from spiraling higher.”There’s no “draconian” in our central bank’s playbook..
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China Crisis Dynamics gained important momentum this week. While this is a significant global development, market focus is elsewhere. And that’s how things tend to play out. The initial phase of instability garners much attention. But then policy responses and a semblance of stability nurture the perception that the situation has been largely resolved. Meanwhile, Credit stress builds and broadens, methodically gravitating from the “Periphery” toward the systemic “Core.”
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There’s still a solid argument for the dependability of the Fed’s liquidity backstop. But surging inflation has significantly clouded the predictability of both the timing and scope of Fed QE responses to market instability. I expect this to increasingly be a key factor in higher pricing and waning liquidity throughout the derivatives universe. This will become a pressing issue as market Bubbles falter.'
- Doug Noland,
Kaufman Knows Inflation, January 14, 2022
Context'QE was specifically meant to lift stock prices..' - Bernanke - '..financial markets are hooked on the Fed’s drug infusions.'