The Boss Has Been Looking Over My Shoulder (Live in 10)The head of the BIS just repeated everything I’ve said about the financial system and central bank rescues for the past half-decade.
Given this Negative Momentum Shift, I’m Opening It Up…
Good morning: Ahead of our morning piece, I want to stress this move BACK into negative momentum. This has a 1% Pattern feel to it, as we have slumped back hard after key moving averages in the Russell 2000 and the Equal Weight S&P 500 both failed to move back above their 20-day moving averages, while the S&P 500 Financial (XLF) couldn’t get back over its 200-day moving average. This is the range where concerns about capitulation, forced selling, and mechanical selling arrive again. This is not a drill. This is where we could see 2% days on the S&P 500 or Russell…
At 9:20 today, I’ll be talking about intraday trading and VWAP over at OptionPit. Good morning: So… it turns out that the next government crisis might not happen when a government runs out of money… It could happen because a hedge fund does. That was a warning on Monday from Pablo Hernández de Cos, general manager of the Bank for International Settlements. The head of the central banks for central banks gave a speech in Vienna, and I found myself nodding along because… well… it’s all so familiar. I’ve been talking about how the lifeguards show up after the market breaks, and the rescue ends up in the hands of someone else before it ever reaches you. The real problem is that the people the Federal Reserve lends to… aren’t the only people holding government bonds. Many of the big ones have no window to go to. After I read this speech again last night, I had this weird feeling that the boss has been reading over my shoulder while I’m typing. I want to highlight the five things that are very familiar from this conversation… and I’ll be revisiting all of them this weekend. No. 1: Leveraged Funds Can Create a CrisisLast year, former Fed Chair and former Treasury Secretary Janet Yellen told CNN International that the U.S. was under stress and that Trump partially paused reciprocal tariffs. At the same time, leveraged funds dumped Treasuries and threatened financial instability. No one on CNN felt it necessary to ask a follow-up question about this statement… and ask… Um… Why are leveraged funds so loaded up on U.S. debt… And what would trigger them to sell… Here’s the answer to that question… Yields rise, prices fall, and margin calls arrive. When that happens, someone can force those funds to sell their bonds to raise cash. This is Leverage 101. All of a sudden, governments figure out how fast their borrowing conditions weaken. Some hedge fund that they don’t even know exists might need cash, and now they’re watching other funds unwind their trades. This includes the basis trade that I’ve explained at length. With that trade, hedging the bond won’t eliminate the need to meet margin demands… No. 2 - Temporary Is a Long TimeNext, de Cos admitted that some “temporary” emergency programs that purchased bonds turned into… long-term stimulus programs. Does this sound familiar if you’ve been reading me for a long time? As a result, central banks blurred the lines between fixing a broken market and stimulating the economy, making these programs very hard to unwind. As I said in the Wave Speech, the rescue infrastructure keeps becoming a permanent fixture. The Federal Reserve built the Standing Repo Facility in 2021 so emergency financing would already be available when the repo market needed it… That’s not the only temporary facility that became permanent… They change the names… A guy I know has a license plate that says “QE 4 Eva.” He understands the prevailing sentiment, even if the license plate doesn’t distinguish between outright purchases and collateralized lending. No. 3: Time to Bail Out Hedge FundsThe GM says central banks are currently considering new lending tools or broader access to existing lending facilities for non-bank financial institutions. That means ensuring that non-bank financial institutions (NBFIs), the hedge funds, pensions, and insurers people call shadow banks, get emergency support to prevent this nonsense from spiraling out of control… This is because these shadow banks operate a system that rivals traditional banking in size, and these non-banks are now the largest holders of government paper in advanced economies. But for now, these lending windows are largely open only to the traditional banking sector. He warns that we require comparable regulation, as non-banks operate under different regulatory regimes, with gaps in oversight and liquidity safeguards. He notes that if they gave that sort of support to non-banks without it, it would encourage them to take more risk. And more risk, in my experience, means another rescue at some point. That said, regulation is stuck in neutral right now. I’m sure we’ll get around to it in 2033 when I predict they’ll create the next Banking Act on the 100th anniversary of the original. Things will get pretty wild before then… No. 4: AI Might Crash It AllDe Cos warns that artificial intelligence can speed up the race for the exit… and this is pretty interesting. The argument goes that various firms are using very similar models to manage equities and bonds, track liquidity, and manage risk. It turns out everyone’s new, expensive intelligence may tell them to sell the same thing at the same time. Remember when everyone thought they had their own edge? We saw the speed problem in 2023, when online banking and social media helped accelerate deposit withdrawals. Now add firms using similar AI models to decide when to sell and raise cash. By the time the central banker reaches the podium, everybody else may already be reaching for the exit. No. 5: How Would We Know What’s Wrong?Finally, I found this to be the one that really spooked me. He noted that central banks could struggle to determine if government bonds are falling because trading has broken down or because investors have legitimate concerns about the government’s finances. De Cos said this… and added that the breakdown often follows news about fundamentals, including fiscal shocks. We might have to rescue the market while we’re still figuring out whether the government deserves the price it’s getting. Keep that in mind as we get to the day’s news. Isn’t finance wonderful? State of the Markets...Continue reading this post for free in the Substack app
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