Doug Noland...Forget FOMO..prepare for the next leg down...Market expectations currently have Fed funds peaking at 3.66% in March of next year. This seems reasonable enough in the context of China’s faltering Bubble, ongoing acute global fragilities, and U.S. market and economic vulnerabilities. But if U.S. securities markets regress to their speculative ways more sustainedly, there’s a scenario where loose financial conditions underpin both economic activity and inflationary pressures. A 5% Fed funds rate in 2023 would not be unthinkable.
I’m assuming surging equities speculation, bustling debt markets, and booming commodities price inflation would alarm Fed officials. A precipitous loosening of financial conditions would catch them by surprise, hastening some serious “neutral rate” contemplation. Barring a market accident, inflationary pressures will not be contained by the level of Fed funds currently anticipated by the marketplace.
At 2.83%, 10-year Treasury yields show little concern for the risk market resurgence. It’s as if bonds become only more confident Things Are Going to “Break.” There are certainly major risks associated with the marketplace turning bullish at this juncture – scrapping hedges while boosting exposures and leverage. It seems to ensure major liquidity challenges come the next bout of de-risking/deleveraging. And let’s not forget that the Fed ratchets up QT (quantitative tightening) next month.
I also worry about the hedge funds. This rally has caught many funds poorly positioned, only compounding performance challenges. As a whole, the industry is under intense performance pressure. Most funds have no choice but to plug noses and jump on the rally. They’ll also be the first to liquidate come the next leg of the bear market, selling right along with the derivatives players as a panicked marketplace rushes to reestablish hedges. And if the recent loosening of financial conditions has been spectacular, just wait until the next de-risking/deleveraging-induced tightening. Let’s call it what it is: Epic Monetary Disorder.