Credit Bubble Bulletin/Doug Noland/5-26-2003
Observations from Credit Bubble Bulletin’s Doug Noland:
“Over-liquefied markets had turned highly speculative and levered. Market structure evolved to become dominated by trend-following behavior, with derivatives, algorithmic trading and hedging strategies creating latent fragility. Recurring bouts of monetary instability and progressively activist central bank market intervention crystalized the perception that central bankers were guarantors of liquidity, stability, and buoyant financial markets.
Here at home, the banking system remains highly levered and vulnerable. There are scores of big securities portfolios that become immediately problematic in the event of a yield spike. And it wouldn’t take much to restart the deposit exodus from vulnerable institutions. The mortgage marketplace is vulnerable to self-reinforcing deleveraging and interest-rate hedging-related selling. And, generally, leverage permeating the entire system creates vulnerability to a surge in market yields.
The Fed is in a bad place. The resurgent stock market speculative Bubble is a major force for loosening financial conditions and stoking inflationary pressures, while risking a melt-up and crash scenario. But additional Fed tightening measures are problematic for the bond market and banking system.
We’re back to the Fed hikes until something breaks. At this point, financial conditions must tighten significantly to keep inflation from becoming only more deeply ingrained. And especially after this speculative stock market run, tighter conditions pierce Bubbles. For now, such loose conditions set the stage for the nightmare scenario – a surprising jump in inflation, a spike in market yields, and a repricing for tens of Trillions of fixed-income securities. Stocks can relish the fun and games. But look over your shoulder, and you might see inklings of de-risking/deleveraging.”
