Jerome Powell, Chairman of the US Federal Reserve, during a federal hearing event in Washington, DC, US, on Friday, September 23, 2022.
Drago | Bloomberg | Getty Images
Such as Federal Reserve Efforts to tame inflation are intensifying, sending the dollar, bonds and stocks up, and concern is growing that a central bank crackdown will have unintended and disastrous consequences.
Markets entered a new, risky phase last week, one in which statistically unusual moves across asset classes are becoming commonplace. The stock sell-off grabs most of the headlines, but it’s taking place in the volatility and interaction of much larger global markets for currencies and bonds as trouble mounts, according to Wall Street veterans.
After being criticized for being slow to recognize inflation, the Federal Reserve embarked on it most aggressive A series of price hikes since the 1980s. From almost zero in March, the Fed pushed the benchmark interest rate to a target of at least 3%. At the same time, the plan to dissolve its $8.8 trillion balance sheet in a process called “quantitative tightening“or QT — the sale of securities the Fed keeps on its books — has removed the largest buyer of Treasuries and mortgage bonds from the market.
“The Fed breaks things,” he said. Benjamin DunnD., a former hedge fund risk manager who now runs Alpha Theory Advisors. “There is nothing really historical that you can point to as to what is happening in the markets today; we are seeing multiple standard deviation moves in things like the Swedish krona, in Treasuries, in oil, in silver, like any other day. These are not healthy moves.”
For now, it is the once-in-a-generation rise in the value of the dollar that has caught the attention of market watchers. Global investors are flocking to higher-yielding US assets thanks to the Fed’s actions, and the dollar is gaining strength while rival currencies shrivel, sending the ICE dollar index into a tailspin. best year Since its establishment in 1985.
“This strength of the dollar has historically led to some kind of financial or economic crisis,” Morgan Stanley Chief Equity Strategist Michael Wilson Monday said in a note. The dollar’s previous peaks coincided with the Mexican debt crisis in the early 1990s, the US tech stock bubble in the late 1990s, and the housing mania that preceded the 2008 financial crisis and the 2012 sovereign debt crisis, according to the investment bank.
The dollar helps destabilize external economies as it increases inflationary pressures outside the United States, Barclays’ global head of FX and emerging markets strategy Themistoklis Fiotakis said Thursday in a note.
He wrote earlier: “The Fed is now in a state of hyperactivity and this is overloading the dollar in a way that, for us at least, was hard to imagine.” “Markets may underestimate the inflationary impact of a stronger dollar on the rest of the world.”
The Bank of England had to against that strong dollar background market support its sovereign debt on Wednesday. Investors have been dumping UK assets in effect since last week after the government unveiled plans to stimulate its economy, moves that run counter to the fight against inflation.
The UK incident, which made the Bank of England the last buyer to pay its debts, could be just the first intervention the central bank is forced to take in the coming months.
There are two broad categories of concerns at the moment: Extreme volatility in what is supposed to be the world’s safest fixed income vehicle could disrupt the plumbing of the financial system, according to Mark Connors, the former global head of risk advisory at Credit Suisse who Join Canadian digital asset firm 3iQ in May.
Because Treasuries are backed by the full faith and credit of the US government and are used as collateral in the overnight financing markets, lower prices for them and the resulting higher returns could lead to the smooth functioning of those markets, he said.
The problems in the repo market occurred as recently as September 2019, when the Federal Reserve They had to inject billions of dollars To calm the repo market, the The basic short-term financing mechanism For banks, companies and governments.
“The Fed may have to fix the Treasury rate here; we’re getting close to that,” said Connors, a market participant for more than 30 years. “What is happening may require them to step in and provide emergency funding.”
Doing so would likely force the Fed to halt its quantitative tightening program ahead of schedule, just as the Bank of England did, according to Connors. He said that while this would confuse the Fed’s messages that it is being tough on inflation, the central bank would have no other choice.
The second concern is that volatile markets will expose weak hands among asset managers, hedge funds or other players who may have taken high risks or took unwise risks. While the explosion can be contained, it is possible that margin orders and forced liquidations could further turmoil the markets.
“When there’s a sharp appreciation in the dollar, expect a tsunami,” Connors said. “Money sinks one area and leaves other assets; there is an indirect effect there.”
He said the increased correlation between assets in recent weeks reminds Dunn, the former risk officer, of the period just before the 2008 financial crisis, when currency bets collapsed. Carry trade, which involves borrowing at low rates and reinvesting in high-return instruments, often with the help of leverage, has The date of the bombings.
“The Fed and all of the central bank’s actions are creating the backdrop for a very large unwind at the moment,” Dunn said.
A stronger dollar also has other effects: it makes it difficult to repay large portions of dollar-denominated bonds issued by non-US players, which could put pressure on emerging markets already suffering from inflation. Other countries could dump US securities in an attempt to defend their currencies, exacerbating moves in Treasuries.
What’s called zombie companies Which has managed to stay afloat due to the low interest rate environment over the past 15 years, is likely to face an “account” of default as it struggles to tap into more expensive debt, according to Tim Wessel, strategist at Deutsche Bank.
Wessel, a former employee of the Federal Reserve Bank of New York, said he also believes the Fed will likely need to discontinue its QT program. That could happen if funding rates go up, but also if the banking industry’s reserves drop too much for the regulator’s convenience, he said.
However, as no one expected to file Mysterious pension fund trading That would spark a series of torn British bond sell-offs, the unknowns of which are most worrisome, says Wessel. He said the Fed is “learning in real time” how markets will react as it tries to rein in the support it has provided since the 2008 crisis.
“The real concern is that you don’t know where to look for these risks,” Wessel said. “This is one of the points of the tightening of financial conditions; it is that people whose tenure is excessively extended pay the price in the end.”
Ironically, it is the reforms that emerged from the recent global crisis that have made markets more fragile. Trading across asset classes is getting thinner and easier to disrupt after US regulators forced banks to step back from monopolistic trading activities, a dynamic c. B. Morgan Chase Executive Director Jimmy Damon Repeatedly.
Regulators did so because the banks took excessive risk before the 2008 crisis, assuming they would eventually be bailed out. While the reforms have pushed the risk out of banks, which are safer today, they have made central banks take on much more of the burden of keeping markets afloat.
With the possible exception of troubled European companies such as Credit SuisseInvestors and analysts said there is confidence that most banks will be able to withstand future market turmoil.
What is becoming clearer, however, is that it will be difficult for the United States – and other major economies – to wean themselves off. Exceptional support from the Federal Reserve in the last fifteen years. He is the world of Allianz Economic Advisor Mohammed Al-Arian Ironically referred to as “no no landThe effect of the central bank.
“The problem with all of this is that it is their policies that have created the fragility, their own policies that have caused the turmoil, and now we are relying on their policies to address the turmoil,” said Peter Bokfar of Bleakley Financial Group. “It is a completely chaotic world.”